Fixed Income Knowledge Hub

Asset-backed securities (ABS) were introduced to the marketplace in the mid-1980s when Sperry Lease Finance created a new type of securitization backed by computer equipment leases. Before the introduction of the Sperry ABS deal, mortgages served as the primary source of securitization.

Since the initial ABS deal, the market has grown and diversified via new securitization types, from auto loans and leases to cell phone payments. According to the Securities Industry and Financial Markets Association (SIFMA), the ABS market represents more than $1.5 trillion and has grown substantially since its emergence in the mid-1980s.

Source: SIFMA, as of 31 Dec 2021.

The ABS market peaked at $2 trillion in 2007 ahead of the global financial crisis and began declining post-crisis amid significantly reduced issuance and continued paydowns on outstanding deals. The market didn't rebound until 2013 when securitization expanded beyond the traditional categories.

Although the ABS market has experienced considerable growth since the mid-1980s, it remains the smallest subset of the fixed income universe, trailing Treasury, corporates, mortgage-backed securities, municipal and federal agency debt.

However, small does not necessarily mean illiquid, concentrated or risky. On the contrary, the ABS market offers investors a chance to diversify by investing in a broad market comprising various asset types. Additionally, these deals' structure allows an investment manager to determine their preferred risk level when investing.

Source: SIFMA, as of 31 Mar 2024. MBS and ABS's most recent available data are as of 31 Dec 2021.

The Bloomberg US Aggregate Bond Index encompasses approximately $127 billion (excluding CLO/CDO) or 8% of the ABS market — a gap presenting opportunities for investors seeking yield and return beyond the index's strict criteria, which include limiting ratings to three major agencies (S&P, Moody's, Fitch) and inclusion to only certain sectors such as credit cards and auto loans. Exploring the extensive portion of ABS not covered by the index demands insightful analysis to uncover promising securities, offering a pathway to potentially enhanced portfolio performance.

Source: SIFMA, Bloomberg.

¹ Property Assessed Clean Energy (PACE) is a financing mechanism that allows property owners to pay for energy efficiency improvements or renewable energy systems.

Since the 1980s, automobile loan securitization has offered investors significant benefits, including diversified loan pools for broad geographic and demographic coverage, tangible collateral security, and short-term exposure through auto loans' shorter average life.

Unlike mortgage-backed securities, auto loan securitizations yield stable payment streams with minimal interest rate volatility. The market caters to varied credit risk preferences, divided into prime (FICO scores above 720), near-prime (mid-to-high 600s to low 700s), and subprime (475-650 FICO scores) categories.

Initially focused on prime and near-prime loans, the auto securitization market expanded to include auto fleets and floorplans, with subprime securitizations emerging in the early 1990s to become a significant segment. This diversification and tranche structuring provides a spectrum of investment opportunities tailored to different risk-reward profiles.

Credit card receivables — the future cash flows expected from borrowers' credit card debt repayments — are pooled and transformed into marketable securities (credit card asset-backed securities, or ABS) that can be sold to investors.

By selling these bundled receivables to investors, credit card issuers gain immediate access to capital rather than waiting for cardholders to pay.

As companies collect on outstanding credit card debts, the funds are used to pay interest monthly with the principal paid off at a pre-ordained pace after a pre-determined period to the investors holding these ABS, creating a continual flow of funds and making it an attractive investment for those looking for regular income streams.

The equipment lease ABS market, rooted in equipment lease contract cash flows, launched in 1985 with $300 million in assets. Over the next two decades, it surged from $300 million to $49.4 billion by 2005 and stands at $80 billion today.

Despite early growth, the industry faced significant challenges, notably the high-profile bankruptcies of National Century Financial Enterprises, DVI, Inc., and NorVergence due to fraud, undermining investor confidence. The 2008 global financial crisis acted as a purging period, with numerous firms exiting the market by virtue of acquisition, bankruptcy or closing. This consolidation left about 20 well-capitalized firms post-crisis, poised for recovery and growth amid reduced competition.

Student loan ABS (SLABS) include loans from the former Federal Family Education Loans Program (FFELP, ended in 2010) and private loans from entities like Sallie Mae and newcomers such as SoFi and CommonBond.

Post–2008 financial crisis, SLABS issuance dropped significantly due to FFELP's discontinuation and the shift to the federal Direct Loan Program. However, firms like SoFi and CommonBond have emerged to fill the gap, focusing on high-earning, well-educated borrowers through social media and online platforms and using innovative creditworthiness assessments beyond FICO scores. This evolving private SLABS market offers new opportunities for investors ready to understand its complexities and assess risk-reward scenarios effectively.

The ABS market's "other" category, despite its vague definition, has emerged as one of the most dynamic and rapidly expanding segments. Over the past decade, this category has seen remarkable growth, expanding by an impressive 150%. It encompasses a diverse range of innovative and unconventional securitizations, reflecting the market's evolving creativity. These include novel deals backed by revenue from IP addresses, as well as more esoteric collateral such as fine art, wine, spirits, and high-end jewelry. This growth underscores the increasing sophistication and adaptability of the ABS market in creating new investment opportunities.

Source: SIFMA