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What Are Asset-Backed Securities?

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What Are Asset-Backed Securities?
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Unfortunately, many Americans first became aware of asset-backed securities (ABS) during the Financial Crisis, when mortgage defaults nearly triggered the collapse of the entire financial system. While irresponsible lending behavior was behind the mortgage bubble, there’s nothing inherently risky in ABS investing. Here’s how it works.

ABS and MBS are actually classes of bonds, much like corporate bonds or government bonds. Instead of being backed by a company or government, ABS are backed by other types of receivables, including credit card receivables, auto loans, student loans and home-equity loans.

Financial institutions originate loans and then turn those loans into investable products via a process known as securitization. The underlying assets behind an ABS, such as auto loans, typically can’t be sold to investors as-is. Instead, pools of loans are sorted, packaged together and then sold to investors.

For the loan issuers, securitizing and selling the loans to investors frees up more cash for the issuer to use to provide more loans. For investors, ABS offer a relatively high-yield source of fixed income and a way to diversify a bond portfolio.

Related Link: What Do Corporate Credit Ratings Mean For Investors?

Credit agencies assess the creditworthiness of ABS and assign a credit rating in the same way they issue ratings on corporate or government bonds. Although ABS got a bad name during the Financial Crisis, most ABS receive AAA ratings (the highest possible) from the major credit agencies.

Although there are very few ABS ETFs out there, the iShares Barclays MBS Bond Fund (NYSE: MBB) is one way for retail investors to easily invest in the MBS market.

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