Credit card, auto loan and solar ABS
Credit card asset-backed securities (ABS) are backed by non-amortizing balances: during a lockout (revolving) period investors receive only finance charges and fees while principal is reinvested, then principal is paid out. Auto and solar ABS are backed by amortizing loans, so investors receive principal from the start and face prepayment as well as default risk.
Before this: Credit enhancement and credit tranching, Securitization: How It Works and Why
On the exam
- Describe types and characteristics of non-mortgage asset-backed securities, including the cash flows and risks of each type
Describe the types, cash flows and risks of non-mortgage ABS. Expect: what investors receive during a credit card ABS's lockout period; what triggers rapid amortization; why auto and solar ABS carry prepayment risk; what a pre-funding period does.
How deeply to learn each part
- Know the idea
- Understand it in general. It frames other topics, but you will not calculate with it.
- Use it
- Understand it well enough to solve a question with it. Recognize when it applies.
- Memorize
- Learn it by heart. The exam will not give it to you.
You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.
You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.
Why does amortization decide the cash flows?
Amortizing loans repay principal in scheduled installments along with interest, so the pool shrinks. Auto loans and solar loans are amortizing. Non-amortizing loans have no scheduled principal repayment. Credit card balances are the main example: a cardholder owes a balance that can be paid down or borrowed against again.
Try this 0 of 3
- Make charge-offs climb from year 2 and find the month principal starts
- Raise auto prepayments until the auto notes' average life is under 2 years
- Set charge-offs to 6% from the start, holding steady
Credit card ABS
Auto loan ABS
- Interest (hatched)
- Principal
Charge-offs stay below the 6% trigger, so card investors get interest only for 36 months while repaid balances buy new receivables. The auto investors get principal from month 1.
Per 100 of notes, both paying 5% a year. The auto loans earn 7%: the gap pays servicing and builds excess spread. Defaults are not drawn.
Show working
Card ABS interest each month = 100 × 5% ÷ 12 = 0.4167; principal once amortization starts = 100 ÷ 60 = 1.6667 a month for 60 months.
Trigger: charge-off rate = 4%, flat. It never reaches 6% in the lockout, so principal starts in month 37.
Auto loans: level payment on 100 at 7% over 60 months = 7% ÷ 12 × 100 ÷ [1 − (1 + 0.583333%)−60] = 1.9801; month 1 scheduled principal = 1.9801 − 100 × 0.583333% = 1.3968.
Monthly prepayment rate = 1 − (1 − 0%)1/12 = 0.0000%; month 1 principal to investors = 1.3968 + 0.0000% × (100 − 1.3968) = 1.3968.
Weighted average life = Σ (month × principal) ÷ 100 ÷ 12: card 5.54 years, auto 2.69 years.
- 2NDCLR TVMwith P/Y set to 1
- 60N0.583333I/Y100+|-PV0FV
- CPTPMT1.9801, the auto loans' monthly payment
- 1−0=y^x(1÷12)=+|-+1=0, the monthly prepayment rate
2ND second function (the shifted label above a key) · CLR TVM clear the time value of money keys · N number of periods · I/Y interest rate per year (per period when P/Y is 1) · +|- change sign · PV present value · FV future value · CPT compute · PMT payment · y^x power
- fCLEAR FIN
- 60n0.583333i100CHSPV0FV
- PMT1.9801, the auto loans' monthly payment
- 1ENTER1ENTER0−121/xy^x−0, the monthly prepayment rate
f gold shift key · CLEAR FIN clear the financial registers · n number of periods · i interest rate per period · CHS change sign · PV present value · FV future value · PMT payment · ENTER enter (on the HP, puts the number on the stack) · 1/x reciprocal · y^x power
- Non-amortizing collateral Memorize no scheduled principal; the pool revolves
- Credit card receivable ABS Memorize finance charges and fees; lockout, then amortization
-
- Amortizing collateral Memorize scheduled principal from month 1; prepayment risk
- Auto loan ABS Use it loans (sometimes leases) secured by the vehicle
- Solar ABS Use it loans or leases for home solar systems
-
| Amortizing (auto loans, solar loans) | Non-amortizing (credit card receivables) | |
|---|---|---|
| Borrower payments | Interest and scheduled principal | Interest and fees; no scheduled principal |
| Investors receive | Interest and principal (scheduled and prepaid) from the start | Interest and fees only during the lockout; principal after |
| Pool over time | Shrinks | Replenished during the lockout |
| Main risks | Default and prepayment | Default; deterioration that triggers early amortization |
How does a credit card ABS pay investors?
Memorize
A credit card receivable ABS is backed by card balances. The pool earns finance charges (interest on balances, often floating with a cap), plus late and annual fees, and cardholders repay principal.
- Lockout (revolving) period Memorize investors get finance charges and fees; repaid principal buys new receivables
- Amortization period Memorize principal is passed to investors
- Rapid (early) amortization Memorize ends the lockout early if the pool weakens; protects investors
During the lockout period , also called the revolving period, the principal that cardholders repay is used to buy new receivables, so the pool stays about the same size. Noteholders receive only finance charges and fees. After that comes the amortization period , when principal is collected and paid out to investors.
A rapid amortization provision protects investors. If defaults rise or the pool cannot be replenished with good receivables, the revolving period ends early and principal is returned to investors straight away.
A card ABS has 1150 of notes outstanding paying 4.80% a year. Interest paid to noteholders each month is closest to:
1150 × 0.048 ÷ 12 = 4.6
Monthly interest4.6
- 1150×0.048=÷12=
- 1150ENTER0.048×12÷
ENTER enter (on the HP, puts the number on the stack)
Card ABS ratings held up well through past downturns, helped by structural protections such as overcollateralization, subordination and the early amortization trigger.
Exam tip In a card ABS the question is always “which phase?” Lockout: interest and fees. Amortization or rapid amortization: principal too.
How do auto loan and solar ABS differ?
Use it
An auto loan ABS is backed by amortizing vehicle loans (sometimes leases) secured by the vehicle. Investors receive principal every month and are exposed to both prepayment and default.
A solar ABS is backed by loans or leases for home solar systems, often to prime homeowners and sometimes secured by a junior lien on the home. Typical enhancements are overcollateralization, subordination, reserve accounts and excess spread. Many have a pre-funding period , which lets the trust add eligible loans after closing. The payment often replaces part of the household’s energy bill, which supports performance, and the bonds appeal to investors with sustainability goals.
An amortizing loan pool with a balance of 400 earns 0.50% a month. The monthly payment is 7.73. The principal repaid is closest to:
7.73 − 400 × 0.005 = 5.73
Principal in the payment5.73
- 400×0.005=interest
- +|-+7.73=
+|- change sign
- 7.73ENTER400ENTER0.005×−
ENTER enter (on the HP, puts the number on the stack)
If borrowers prepay, more principal arrives sooner and the interest stream shrinks. That is prepayment risk, and it is why amortizing ABS differ from a card ABS in its lockout.
For solar, take Sunrise Rooftop Trust. It issues USD 450 million of notes against USD 486 million of amortizing solar loans. The overcollateralization is USD 36 million, or 36 ÷ 450 = 8% of the notes.
Go deeper Why card issuers securitize
A card lender securitizes to fund the receivables more cheaply, to use less capital and to keep earning fee income on the accounts while investors fund the balances.
Go deeper Floating finance charges with caps
If the finance charges are floating but capped, a jump in rates can push the note coupon up while the cap holds the pool’s income down. Excess spread then shrinks, and the first cushion against losses gets thinner.
Go deeper Solar ABS and green labels
Solar ABS finance clean energy, so some are labeled as green. Covered bonds can carry the same label when they are backed by green mortgages. In both cases the label describes the use of the assets, not an extra layer of credit protection.
Memorize this
MemorizeWho gets what
| Card ABS (non-amortizing) | Auto and solar ABS (amortizing) | |
|---|---|---|
| Borrower pays | Interest and fees; no scheduled principal | Interest and scheduled principal |
| Investors receive | Interest and fees only in the lockout; principal after | Interest and principal from the start |
| Pool over time | Replenished in the lockout | Shrinks |
| Main risks | Default; weakness that triggers early amortization | Default and prepayment |
Memory hook Cards are revolving credit: the pool is a treadmill, so principal waits. Loans amortize: the pool melts, so principal flows from day one.
Know it cold Rapid amortization is triggered by a weaker pool (rising defaults) and returns principal early. Solar ABS add a pre-funding period.
- Non-amortizing collateral Memorize no scheduled principal; the pool revolves
- Credit card receivable ABS Memorize finance charges and fees; lockout, then amortization
-
- Amortizing collateral Memorize scheduled principal from month 1; prepayment risk
- Auto loan ABS Use it loans (sometimes leases) secured by the vehicle
- Solar ABS Use it loans or leases for home solar systems
-
- Lockout (revolving) period Memorize investors get finance charges and fees; repaid principal buys new receivables
- Amortization period Memorize principal is passed to investors
- Rapid (early) amortization Memorize ends the lockout early if the pool weakens; protects investors
Quick example
Card ABS notes of 600 pay 5.4% a year. 600 × 0.054 ÷ 12 = 2.7 of interest a month.
- 600×0.054=÷12= 2.7
- 600ENTER0.054×12÷ 2.7
ENTER enter (on the HP, puts the number on the stack)
Quick example
A pool of 200 at 0.5% a month with a payment of 3.87. Interest is 200 × 0.005 = 1.00, so principal is 3.87 − 1.00 = 2.87.
- 200×0.005= 1
- +|-+3.87= 2.87
+|- change sign
- 3.87ENTER200ENTER0.005×− 2.87
ENTER enter (on the HP, puts the number on the stack)
How it is asked
-
What investors receive in the lockout
During the revolving period of a credit card ABS, investors receive...
Finance charges and fees only. Trap: scheduled principal and interest.
-
Rapid amortization trigger
A rapid amortization provision is most likely triggered by...
A rise in defaults (charge-offs breaching a trigger). Trap: falling interest rates.
-
Risk of amortizing ABS
Compared with a card ABS in its lockout, an auto ABS investor is most exposed to...
Prepayment risk. Trap: reinvestment into new receivables.
Exam traps
- Saying card ABS investors receive principal during the lockout. They get finance charges and fees; principal buys new receivables.
- Thinking rapid amortization hurts investors. It returns principal early when the pool weakens, so it protects them.
- Forgetting that amortizing ABS carry prepayment risk. Auto and solar ABS investors face prepayment as well as default.
- Treating all non-mortgage ABS alike. First ask whether the collateral amortizes.
Checkpoint
4 exam-style questions. About 90 seconds each.
1During the revolving period of a credit card receivable ABS, investors most likely receive:
2A rapid amortization provision in a credit card ABS is most likely triggered by:
3Compared with a credit card ABS in its lockout period, an auto loan ABS investor is most exposed to:
4A credit card ABS has GBP 1,380 million of notes outstanding paying a coupon of 5.2% a year. The monthly interest paid to noteholders is closest to:
Key takeaways
- Non-amortizing card pools revolve: investors get interest and fees first, principal later.
- Rapid amortization returns principal early if the pool weakens.
- Auto and solar ABS amortize: principal from the start, prepayment plus default risk.
- A pre-funding period lets a trust add eligible loans after closing.
Quick example
Card ABS notes of 600 pay 5.4% a year. 600 × 0.054 ÷ 12 = 2.7 of interest a month.
- 600×0.054=÷12= 2.7
- 600ENTER0.054×12÷ 2.7
ENTER enter (on the HP, puts the number on the stack)
Quick example
A pool of 200 at 0.5% a month with a payment of 3.87. Interest is 200 × 0.005 = 1.00, so principal is 3.87 − 1.00 = 2.87.
- 200×0.005= 1
- +|-+3.87= 2.87
+|- change sign
- 3.87ENTER200ENTER0.005×− 2.87
ENTER enter (on the HP, puts the number on the stack)
All Fixed Income formulas, every lesson
Practice exam-style questions on Asset-Backed Securities, Covered Bonds and CDOs
Questions about this lesson?
Where this comes back
- Collateralized debt obligations and CLOs Asset-Backed Securities, Covered Bonds and CDOs
- Mortgage-Backed Securities: RMBS, CMOs and CMBS Fixed Income
Questions candidates ask
How do credit card ABS work?
Card balances are pooled. During a revolving period investors receive interest and fees while repaid principal buys new receivables. Afterwards principal is paid to investors.
What is a rapid amortization provision?
A trigger that ends the revolving period early and starts returning principal if the pool's performance deteriorates.
What is solar ABS?
Asset-backed securities backed by loans or leases for residential solar systems.
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