ABS and MBS Index

Article byWallstreetmojo Team
Edited bySusmita Pathak
Reviewed byDheeraj Vaidya, CFA, FRM

What Is An ABS And MBS Index?

An ABS and MBS index refer to the respective indices that offer exposure to the asset-backed securities (ABS) and mortgage-backed securities (MBS), respectively. The indices when referred to helps set performance standards for the securities in question and also help in trading to gain maximum profits.

The ABS and MBS indexes consider two different types of assets to reflect their performances on a public platform. With the help of these indices, investors and traders learn about the market’s performance and the future health of the industries. This helps them make wiser investment decisions, while making traders identify fruitful trades and take them accordingly.

Key Takeaways

  • ABS (Asset-Backed Securities) and MBS (Mortgage-Backed Securities) indices are benchmarks tracking the performance of pools of such securities. They offer diversification without individually selecting and managing each security.
  • These indices reflect market trends, sentiment, and factors affecting asset-backed or mortgage-backed securities. Investors can monitor the overall market performance through these indices.
  • ABS and MBS indices are benchmarks for comparing specific securities or investment products. They help assess investment performance relative to the index.
  • Investing in ABS and MBS indices allows investors to gain exposure to various underlying assets, facilitating portfolio diversification.
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ABS And MBS Index Explained

ABS and MBS Index signify two different indices to benchmark performance of the asset-backed and mortgage-based securities, respectively. The investors, traders, and brokers get exposure to the ABS and MBS type of securities they are aiming to deal in. Referring to these indices let them choose their security and take trades that seem favorable.

As the market deepens, various indices are created about the functioning and rate of change in the assets which are also useful for determining value of a derivative instrument, which are of two types:

  • Asset-backed securities index (ABS) shows the market performance of ABS Market which is calculated as the weighted average of a portfolio of ABS, and
  • Mortgaged backed securities (MBS) index shows the MBS market movement as the weighted average of bonds and promissory notes backed by only property mortgages.

These indices are developed to get a sense of how the market is performing. They are also used as the base for derivativesDerivativesDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts. read more, which are instruments that take their value from the movement of the indices..

To understand the exposure these indices offer t investors and traders, it is important to explore more about ABS and MBS.

Financial institutions can pool receivables, be it loans or the credit that they have extended, which have similar tenure and risk profileRisk ProfileA risk profile is a portrayal of the risk appetite of an investor. It is done by assessing an individual’s capacity, interest, and willingness to take and manage risks. Preparing it helps financial advisors to assist clients in making effective investment decisions. read more and sell it to investors. These pools are typically in the form of a bond or promissory notePromissory NoteA promissory note is defined as a debt instrument in which the issuer of the note promises to pay a specified amount to a party on a particular date.read more. These securities are called Asset-Backed SecuritiesAsset-Backed SecuritiesAsset-backed Securities (ABS) is an umbrella term used to refer to a kind of security that derives its value from a pool of assets, such as bonds, home loans, car loans, or even credit card payments.read more (ABS). The investor in these securities owns a part of the loan or receivable. This allows the institution to turn its illiquid assets into ready cash to use in their business. The typical assets which are securitized into Asset-Backed Securities (ABS) are credit card receivables, leases, company receivables, royalties, etc.

Mortgage-Backed Securities (MBS) are a subset of ABS and are backed by mortgages on residential properties, i.e., home loans. MBS is a subset of the ABS that contains a specific type of assetSpecific Type Of AssetAssets are the resources owned by individuals, companies, or governments expected to generate future cash flows over a long period. There are broadly three types of asset distribution: 1. Based on convertibility (current and non-current assets), 2. Physical existence (tangible and intangible assets), 3. Usage (operating and non-operating assets)read more.

barclays-abs-index-1

Source: Barclays

ABX Index

An ABS index is a method of measuring the value of the ABS market. It is a weighted average value of a portfolio of the Asset-backed securities. Different indices use different ABS in varying proportions as weights to determine the value Index h index. Hence an ABS Index is the weighted average value of various ABS bonds/ promissory notes traded in the market.

ABS index

An MBS Index is a kind of ABS index that takes the weighted average value of bonds/ promissory notes, which are backed only by property mortgages.

The major risk that ABS bonds face is the interest rate and prepayment riskPrepayment RiskPrepayment Risks refers to the risk of losing all the interest payments due on a mortgage loan or fixed income security due to early repayment of principal by the Borrower. This Risk is most relevant in Mortgage Borrowing which is normally obtained for longer periods of 15-30 years.read more. Interest rate riskInterest Rate RiskThe risk of an asset's value changing due to interest rate volatility is known as interest rate risk. It either makes the security non-competitive or makes it more valuable. read more is what the entire market faces with regard to market-wide. Many people, rather than investing in any single ABS bond, prefer to invest in a portfolio to mitigate their price risk. Any instrument like an exchange-traded fund (ETF), which mirrors the ABS index, would offer such an investment avenue.

ABS Indices are of different types, with some specialized indices consisting of bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more with assets as auto loans or credit cards or mortgages only, while there are other broad-based ABS indices that have bonds backed by assets of all types.

In the US, the Asset-Backed Securities were first introduced in the 1980s, and hence the market is mature and deep enough to have numerous ABS indices. These indices are designed by financial institutions like investment banks as a product for their clients.

und (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange.” url=”https://www.wallstreetmojo.com/exchange-traded-funds-etf/”]Exchange-traded funds[/wsm-tooltip] (ETFs) have also been developed, which invest in all the bonds of the ABS index in the same proportion. These funds, which are like mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more, allow investors to put their money in a number of ABS bonds without actually investing in each of them but give them the return of an ABS portfolio.

MBS Index

As home mortgages form a very large part of the lending portfolio of the financial system, Mortgage-Backed Securities (MBS) form a majority of the securitization market. The ABS market evolved from the MBS market when it had matured, and the market needed newer avenues of financing. The ABS market represents a higher risk than the MBS as they are usually shorter in duration and their cash flows are not as predictable. Also, there is a credit risk, which is higher as it is not easy to separate the legal and financial aspects from the originator of the loans. Also, obtaining information about the ABS is more cumbersome as there are a wide number of institutions that are involved in it from loan originationSecuritizationtion.

Tracking the MBS market helps in analyzing the health of the economy to a large extent as most mortgages have not defaulted unless it is really unaffordable for the homeowner to pay. If a large number of people start defaulting, it is a clear indication that the economy is tanking. Hence there are numerous MBS indices in the US that track this market. Not only are there broad-based indices that track a large part of the market, but there are also numerous specialized MBS indices that track a part of the MBS market like only those MBS which are backed by “ subprime mortgages” or those which “issued for a certain number of years” etc.

Examples

Let us consider the following types of ABS and MBS indices available for investors and traders to refer to:

Example 1 – ABS Index

#1 – Barclays U.S. Floating-Rate Asset-Backed Securities (ABS) Index includes Asset-Backed Securities of one year or more maturity, with $250 million outstanding and has home loans, credit cards, auto loans, and student loans as the “assets.” The one year return Indexes index as of June 30, 2016, was 4.06%.

#2 – JP. Morgan ABS Index has over 2000 ABS instruments in the US market which are backed by different assets like auto and Equipment, Credit Card, Student Loan, consumer loans, timeshare, franchise, settlement, tax liens, insurance premium, servicing advances, and miscellaneous esoteric asset index is index aims to capture about 70% of the ABS market and also have sub-indices that track specific sector ABS instruments.

jpmorgan-abs-index

source: www.businesswire.com

ABS indices in Europe

In Europe also the ABS market is also quite matured and there are many pan European ABS indices that comprise of Asset-backed securities issued by European originators. There are ABS Indices in various other countries also. Some of them are:

#1 – Barclays Pan European ABS Benchmark Index includes bonds that are backed by residential and commercial mortgages, auto loans, and credit cards with a Eu 300 million outstanding with at least one-year maturity.

#2 – European Auto ABS Index comprises Auto loan-backed securities issued by European originators.

#3 – Mexico’s Autofinanciamiento ABS Index comprises Mexican Auto loan-backed securities. In the US and Europe, many Fannie MaeFannie MaeFannie Mae, i.e., Federal National Mortgage Association is a United States government-sponsored enterprise (GSE) which was founded in the year 1938 by congress to boost the secondary mortgage market during the great depression which involves financing for the mortgage lenders thereby providing access to affordable mortgage financing in all the markets at all times.read more (FNMA) and Freddie Mac (FHLMC)” where GNMA, FNMA, and FHLMC are institutions which issue the MBS

sp-mbs-index

source: S&P

#2 – S & P US Mortgage Backed FHLMC 30 Year Index is a subset of the above S&P U.S. Mortgage-Backed Securities Index and tracks FHLMC issued 30 year MBS bonds.

#3 – The Deutsche Bank Liquid MBS Index tracks the most liquid MBS in the US market.

db-liquid-mbs-indexsource: db.com

In India, the ABS market has not yet evolved too much. The main asset classesMain Asset ClassesAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples.read more in this market are bonds backed by auto loans, microloans, and residential mortgages. In 2013 DLF Ltd., a property development company, issued a bond backed by rental income from its office buildings. In India, ABS has NBFC Full-FormNBFC Full-FormNBFC (Non-Banking Financial Companies) are responsible for offering various services similar to that of the banking companies like providing of loans/advances to the businesses and others, hire-purchase, leasing, acquisition of various securities such as shares, debentures, bonds, stocks, etc.read more as originators and banks as investors. Banks usually invest in these asset-backed bonds to meet their “priority sector” lending norms. As the asset-backed microloans or auto loans to farmers, these help banks meet their priority sector lending. With the existing legal and tax structures, the securitization market in India is very nascent with very low demand. Due to this, there has been no need for the evolution of an ABS index.

ABS/MBS Indices and Economic Crisis

One of the biggest contributors to the 2009 economic crisis in the US has been the subprime mortgage lending, i.e., lending to entities that do not have perfect credit and have a greater risk of default. The mortgage lending was further fuelled by Securitizationtion available for these loans, which led to the market being flush with funds for further lending. It was a non-virtuous cycle of subprime lending being fuelled by more and more money being risked in the same high-risk lending. When the borrowers started defaulting, the market collapse was exacerbated as not only did the lenders lose their money but also all those who had invested in the ABS bonds, which were issued by securitizing these loans. The other set of investors who lost their money were those who invested in ABS indices linked ETFs.

When the loans have defaulted, the bonds lost their market price, which in turn led to a collapse of the ABS/ MBS indices and hence all the ETFs linked to them. So one set of defaults had a cascading effect affecting three different sets of investors, i.e., the lenders, the ABS investors, and investors in ETFs of ABS indices. Though MBS has been said as a major factor in the credit crisis, it has to be said that the instrument by itself was not a reason, but the subprime loansSubprime LoansSubprime loans are given to entities and individuals by the bank, usually on a rate of interest much higher than the market, which has a significant amount of risk involved regarding its repayment in the specified amount of time.read more backing these instruments were the cause. Until the credit crisis, the market had been very creative in issuing MBS and ABS instruments, but after the crisis, the emphasis has been on the simplicity and stability of the instrument and issuer. The issuance of exotic instruments made the indices difficult to construct and predict as there were new issues at frequent intervals with different assets and complexities in the cash flows.

Frequently Asked Questions (FAQs)

1. What are the key factors affecting ABS and MBS indices?

Key factors affecting ABS and MBS indices include interest rate movements, the credit quality of the underlying assets, prepayment risks, and market demand for asset-backed securities. Economic conditions, regulatory changes, and investor sentiment can impact ABS and MBS indices.

2. Can ABS and MBS indices be used as benchmarks for investment performance?

ABS and MBS indices can be used as benchmarks for investment performance in the respective asset classes. Investors and fund managers compare their returns against the performance of relevant indices to evaluate their investment strategies and measure their success.

3. How do ABS and MBS indices differ from other fixed-income indices?

ABS and MBS indices differ from other fixed-income indices in that they track the performance of asset- and mortgage-backed securities specifically. They reflect the unique characteristics and risks of these structured financial products, distinguishing them from traditional bonds or other fixed-income instruments.

This has been a guide to what is ABS and MBS Index. Here, we explain the concept along with its examples and also the economic crisis associated with it. You may also have a look at the following related articles as well:

Reader Interactions

Comments

  1. Jorge Charles says

    Thanks for explaining Assets backed securities and Mortgage securities in such a brief way.. I really like your work. Doing great. Keep it up!! i have one query related to this subject only. If you could explain me about RMBS, CMBS and CDOS, please share if you have any study related to this. Thanks in advance

    • Dheeraj Vaidya says

      thank you. I am glad you liked this. If you want to know what RMBS, CMBS and CDOS is. Here, I have a detail guide on Assets Backed securities in which I have discussed these 3 things in detail. I have also given a structure how to create RMBS, CMBS and CDOS. Happy learning.

  2. Tristan Parsons says

    Thanks for sharing such valuable information as u always do. Great works keep it up. Although I want to say that you have explained well in detail about Asset securitization. If could also tell me some benefits of asset securitization? I would have appreciated more. Waiting you to revert back with some benefits.

    • Dheeraj Vaidya says

      Tristan, thanks for the appreciation. Well you have a nice question, There are some benefits of assets securitization which I will like to tell you. First benefit is for Originators. Asset securitization improves ROC i.e Return on capital. And the second benefit is for Investors, securitized assets offer a greater liquidity security in market and also offers a combination of attractive yield. Last benefit is for Borrowers, benefit from the increasing availability of credit on terms which lenders may not have provided and they kept the loans on their balance sheets. You can also look at Asset Backed Securities for further details