KOREA CAPITAL MARKET INSTITUTE

Asset backed securities (ABS) are one of the tools a financial or non-financial firm use to raise capital by issuing securities based on its assets. In theory, ABS take the form of bonds, and thus their prices are determined by the sum of the values obtained by discounting the security’s future cash flows at a rate reflecting the credit risk, just as how conventional bonds are priced. However, the issue yield spread of Korean ABS is high over Korea Treasury Bonds (KTB) with the same maturity, and even higher than the spread of corporate bonds with the same maturity and credit rating.

This study is purposed to explore the credit spread between ABS and KTB, and the excess spread of ABS relative to comparable corporate bonds, and to conduct a series of empirical analyses on the factors affecting the spreads.

Korea’s ABS market was orderly introduced when the Asset-backed Securitization Act was enacted in September 1998. Since then, the market gained momentum as diverse underlying assets have been adopted. Also, numerous changes taking place in market conditions have substantially reshaped the asset composition and securitization structure. In terms of the issuance structure, Korea’s ABS exhibit wildly varying characteristics (e.g., the maturity, credit rating, credit enhancement, and securitization structure, etc.) across underlying assets. For example, MBS based on long-term assets have longer maturities whereas CDO have shorter maturities and stronger credit enhancement. To securitize project finance loans, a structure is designed to avoid any restriction on asset owners, and to enhance credit with guarantees provided by constructors. As such, Korea’s ABS market has starkly different maturities, and diverse structures for securitization and credit enhancement across underlying assets.

The data on ABS issue yields show that ABS have a positive spread over KTB due to the credit risk. Also, ABS have a statistically significant, and continuous positive spread over comparable corporate bonds. 

According to the data on term spreads, the spread between ABS and KTB with the same maturity has fallen since the introduction of ABS, with some abrupt widenings at times of crisis such as Korea’s credit card debacle, and the global financial crisis. Also, ABS spreads vary across underlying assets. 

The ABS spread relative to corporate bonds with same conditions remains positive, if all types of ABS are included. By underlying asset, MBS have a minus spread over comparable corporate bonds, while ABS with other underlying assets always have a higher spread relative to comparable corporate bonds.

This study tries to look at the factors affecting ABS spreads via an empirical analysis on publicly-offered, senior-tranche ABS by establishing a regression analysis model that adopts not only common bond factors and liquidity factors, but also ABS-specific factors. 

The results of the regression analysis reveal that the ABS spread over KTB is affected significantly by not only common factors such as the credit spread and maturity, but also the liquidity factors such as the issuance size. Also, statistically significant impacts are found in ABS-specific factors, such as the asset owners’ credit rating, credit enhancement level, and the bank credit provision dummy variable, etc. Those results well support the impact of common factors as well as the ABS structure on ABS prices.

To look at the impact of any change in market conditions on ABS spreads, I adopt the time dummy variable to carry out a regression analysis on spread determinants. The result confirms a statistically significant impact of the dummy variable during the credit crisis period, which evidences a higher price sensitivity of ABS when the market risk increases. 

An empirical analysis on the factors affecting the excess spread of ABS relative to corporate bonds demonstrates that the maturity and credit rating affect ABS spreads even when the credit risk and maturity are controlled, and that all ABS-specific factors have an impact. Such results could be interpreted as that ABS have a higher sensitivity to the maturity and credit rating compared to corporate bonds, and that ABS-specific factors are reflected in the issue yield and then in the spread.

Furthermore, the analysis using the time dummy variable to see the impact on the excess spread relative to corporate bonds shows widening ABS spreads at times of credit crunches.

In another regression analysis dividing ABS into four categories (general ABS, MBS, CDO, and securitization of project finance loans), different price determinants are found across different underlying assets. Such a finding supports that the differences in asset characteristics and securitization structures across types of underlying assets are reflected to determine ABS spreads. 

The aforementioned results in this study provide the following implications for the development of Korea’s ABS market.

First, compared to corporate bonds, ABS carry additional risk factors, which is reflected in price determination. Thus, investors in ABS need to make their investment decision fully taking those factors into account. 

Second, regulators should formulate plans to bolster information provision with regard to ABS structures and characteristics. In particular, it is necessary to strengthen information provision on asset performance, which can be a basis for performance-based investment analyses and thus help improve market efficiency. Moreover, disclosure on securitization needs improving so that more information on underlying assets is disclosed and more data are provided to assess the risks in ABS.

Third, further plans are necessary to facilitate the secondary market in order to enhance the efficiency of the ABS market. It is recommended to devise plans to lower ABS spreads by establishing an efficient secondary market for ABS.  

Fourth, the market structure should be designed for a diversity of underlying assets by introducing a regulatory regime for revitalizing ABS, and adopting a more flexible institutional framework.