What are ABS?

The Asset-Backed Securities

INGEGNERIA FINANZIARIA | ABS | FINANZA
cnbc.com

Today we will talk about ABS. First of all, let’s clean-up doubts: we are not talking about Antilock Braking System, that is mechanics. Rather, we refer to the Asset Backed Securities blamed, by most journalists (and even by some economists), as one of the causes of the collapse of global financial markets in 2008.

Back in vogue thanks to their purchases by major central banks – the ECB is next to an intervention – the ABS are actually financial instruments that, only after an unorthodox use of the instruments themselves, have caused harmful results.

But is it correct to arraign an instrument (or invention) of something that in reality is only due to his erroneous use by humans? We think this is a wrong choise.

The Asset Backed Securities are derivatives, in other words securities whose performance is linked to that of a predetermined underlying asset. In the specific case of ABS, the underlying is generally represented by loans granted by banks to certain categories of customers, whether individuals or businesses. Basically, we are talking about tools whose purpose is to synthesize a “package” of real loans into a single new financial instrument.

The assets grouped into the ABS have relatively small amounts and they are not readily convertible into cash, therefore taken individually they may not be traded on a market. Conversely, through their grouping by holders of portfolios of loans or other assets (namely, Originators), these assets may be sold to an SPV – Special Purpose Vehicle. This new entity, formed ad hoc to “transform” the underlying real assets in securities representing the same activity, it is also in charge of issuing the securities to be sold to private or institutional investors.

The proceeds from the placement will be finally used to compensate the Originators (typically banks or other financial institutions). This process is called Securitization.

In accordance with the provisions described above, it is clear that as long as the ABS refer to underlying assets that are sufficiently “reliable”, the process can be considered efficient. Throuogh this process, in fact, it is possible to free resources to be again invested in the market and, at the same time, “clean-up” the banks’ balance sheets from lower quality loans. Conversely, where the use of Asset-Backed Securities determines granting loan to persons who (most likely) will not be able to repay their loans – which will, in the end, be “dumped” to small investors – we are facing with an incorrect use of the tool.