Asset-Backed Security (ABS)
A financial security collateralized by a pool of income-generating assets such as auto loans, credit card receivables, or student loans.
What is Asset-Backed Security?
An asset-backed security (ABS) is a financial instrument backed by a pool of non-mortgage assets — commonly auto loans, credit card receivables, student loans, or equipment leases — whose cash flows are passed through to investors. ABS are created through securitization: the originator sells assets to a special purpose vehicle, which issues securities in tranches with varying priority of payment. ABS provide liquidity to originators (banks and lenders can recycle capital), and give investors access to diversified pools of consumer credit. Unlike mortgage-backed securities (MBS), which are a specific type of ABS, general ABS are backed by non-real-estate assets and typically have shorter maturities.
Example
An auto lender originates $600 million in car loans at 7% average rate. It packages them into an ABS: $540M senior AAA-rated notes, $42M A-rated mezzanine notes, and $18M equity. Monthly car loan payments fund monthly interest and principal payments to ABS investors. The AAA notes offer a 5.2% yield; the equity tranche bears first-loss risk but earns higher returns if defaults stay low.
Source: SEC — Asset-Backed Securities Disclosure and Registration