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Analysis of Securitized Asset Liquidity
Financial Industry Regulatory Authority (FINRA) Office of the Chief Economist

Research Quarterly, Third Quarter 2017
Securities Industry and Financial Markets Association (SIFMA)

NAIC Capital Markets Special Report: U.S. Insurance Industry Cash and Invested Assets at Year-End 2016
August 24, 2017


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Asset-Backed Securities

Last Updated 1/4/18

Issue: Asset-backed securities (ABS) are bonds backed by various types of financial assets. Typically these assets consist of receivables other than mortgage loans, such as credit card receivables, auto loans, and student loans. 

Overview: Asset-backed securities evolved out of the mortgage-backed securities (MBS) market. Compared with MBS, asset-backed issues have been relatively unaffected by swings in interest rates. The reason is that the car loans and other loans backing ABS have shorter maturities than mortgages, and therefore people are less likely to refinance when interest rates fall.

Unlike conventional corporate bonds, which are usually unsecured, ABS benefit from credit enhancement. Credit enhancement takes place when a security’s credit quality is raised above that of the sponsor’s unsecured debt or that of the underlying asset pool. A variety of internal and/or external credit supports are employed to increase the likelihood that ABS investors will receive the cash flows to which they are entitled.

Key to the health of the overall ABS market is the performance of the consumer sector. The three largest consumer ABS asset classes — auto loans, credit card receivables, and student loans — define, to a large degree, the tone and direction of the non-mortgage ABS market.

ABS issuance is expected to end 2017 at about $205 billion, up from $176 billion in 2016, according to a recent report by Wells Fargo Securities. However, even at the $200 billion level, this year’s ABS issuance is below its pre-financial crisis levels.

The outstanding amount of ABS was $634 billion as of Q3 2017, at about the same level as 2014 and approximately equal to 2002. The peak was recorded in 2007, just before the financial crisis, at $850 billion. The overall composition of the ABS market has changed, reoriented to consumer credit sectors.

Asset-backed securities have proven over the years to be stable investments attracting many investors, among them insurance companies. Insurers have always been major ABS investors with a total industry exposure of about $299 billion as of year-end 2016 (excluding Commercial Mortgage-Backed Securities [CMBS] and Residential Mortgage-Backed Securities [RMBS]). This represents an increase of 9% over the previous year.

The  ABS  sector  rating  outlook  from Fitch Ratings is  stable with performance   remaining  largely  in  line  with expectations. ABS  should  continue  to  benefit  from  a  solid   macroeconomic  environment  and  adequate  structural  protection  in  place.

Given  that  the  majority  of  ABS  assets  are  fixed-rate, the  direct  effect  of  higher  rates  through a higher debt service will be limited. However, increasing rates may indirectly affect  ABS  asset  performance  by  making  new credit  and  refinance  options  more  costly  for   consumers. A surge in interest rates may weigh heavily on borrowers’ debt service capacity and consumer asset performance.

Status: All ABS rated by an NAIC credit rating provider (CRP) are exempt from filing with the Securities Valuation Office (SVO) of the NAIC.  An NAIC CRP is a  nationally recognized statistical rating organization (NRSRO) that has applied to sell credit ratings to the NAIC and been approved by the Valuation of Securities Task Force to do so. Filing exemption means insurance companies can purchase ABC securities on the basis of their credit rating because they understand the corresponding NAIC Designation that would apply to the security. Any ABS benefiting from a guarantee issued by a CRP-rated entity and is not rated by an NAIC CRP needs to be filed with the SVO for an NAIC Designation. The SVO may assign an NAIC Designation relying on the NAIC CRP rating assigned to the guarantor per the information requirements and the analytical procedure described in the Purposes and Procedures of the NAIC Investment Analysis Office.

Effective January, 1, 2018, the SVO will take over administration of the FE process and therefore the SVO will assign all NAIC Designations to securities rated by NRSROs.