Reading 58- Difficulties with ABS and Credit Card receivable-backed securites

  1. Auto Loans ABS It says thar refinancing is not a major factor contributing to auto loan prepayments because - Loan balances are usually very small, reducing the extent of savings resulting from refinancing, especially because used-car refinancing rates are significantly higher than new car rates. CAN SOMEONE EXPLAIN ME THIS SENTENCE? REFINANCING IS EQUAL TO PREPAYMENT AND WHICH SAVINGS RESULTIN FROM REFINANCING?? 2) Early amoritzation trigger protects the investor against declines in the credit quality of ther underlying receivables. The most common trigger is when the 3-month average excess spread earned on the receivables declines to zero. Hence, an early amortization trigger provision creats the potential of contraction risk in a receivables- backed security. ----> HERE I DONT UNDERSTAND THAT IF THE CREDIT QUALITY OF THE UNDERLYING RECEIVABLES IS DECLINING, WHY SHOULD THERE BE ANY CONTRACTION RISK?? THANKS FOR YOUR HELP!!!

yellayella Wrote: ------------------------------------------------------- > 1) Auto Loans ABS > > It says thar refinancing is not a major factor > contributing to auto loan prepayments because > - Loan balances are usually very small, reducing > the extent of savings resulting from refinancing, > especially because used-car refinancing rates are > significantly higher than new car rates. > > CAN SOMEONE EXPLAIN ME THIS SENTENCE? REFINANCING > IS EQUAL TO PREPAYMENT AND WHICH SAVINGS RESULTIN > FROM REFINANCING?? If you have a $5,000 car loan fixed at a rate of 6% and interest rates drop from 5% to 6%, it’s not worth it to you to refinance your loan for such a small saving (i.e you would probably have to pay a break fee or something to get out of your current loan and you would only be saving 1% of $5000 if you got a new loan at the lower rate) > > 2) Early amoritzation trigger protects the > investor against declines in the credit quality of > ther underlying receivables. The most common > trigger is when the 3-month average excess spread > earned on the receivables declines to zero. Hence, > an early amortization trigger provision creats the > potential of contraction risk in a receivables- > backed security. > > ----> HERE I DONT UNDERSTAND THAT IF THE CREDIT > QUALITY OF THE UNDERLYING RECEIVABLES IS > DECLINING, WHY SHOULD THERE BE ANY CONTRACTION > RISK?? I think it means that if credit quailty start declining, it will trigger the early amortization trigger which results in early repayment of the loans - which is essentially the manifestation of contraction risk of the investment

a trigger breach (these breaches are put in place to protect the investor) will cause the ABS to wind-down and this will mean that generally you get your money back quicker hence contraction risk.