Asset-backed securities (ABS) are structured bonds or notes backed by financial assets, such as mortgages, credit card receivables, auto loans, student loans, equipment leases, manufactured-housing contracts and home-equity loans. The creation of these securities is complex and opaque. Financial institutions sell pools of such loans to a special-purpose vehicle (SPV), which sells them to a trust, which repackages the loans into securities that are divided into various tranches or risk preferences, which are then issued by the trust and sold to investors by the investment banks that underwrite them.
In the years leading up to the financial crisis, high-risk loans made to subprime borrowers proliferated. Financial institutions were incentivized to generate so many potentially toxic loans because they could package them as securities, transfer the risk to another institution, and receive cash in return.
Securities backed by toxic assets imploded during the financial crisis, resulting in billions of dollars of losses for investors. Investigations revealed that the selling banks failed to disclose the risks, especially the low quality of many of the underlying loans. Investigations also revealed that investors were misled by false ratings issued by conflicted ratings firms and claims of credit enhancements and protections that turned out to be illusory.
Risky asset-backed securities reached many retail investors through mutual funds, such as Regions Morgan Keegan (RMK) bond funds, which lost $2 billion in 2007. According to experts, these bond funds collapsed because they held concentrated holdings of low-priority tranches in risky asset-backed securities. RMK was accused of misrepresenting hundreds of millions of dollars of highly leveraged asset-backed securities as corporate bonds and preferred stocks, and failing to disclose the risks it was taking to investors until after the losses occurred.
The U.S. Securities and Exchange Commission has promulgated new regulations pursuant to the Dodd-Frank financial overhaul law, which are ostensibly designed to bring transparency to these complex and opaque investments.
One new SEC regulation requires banks and other financial firms that sell asset-backed securities to review the quality of the underlying assets, including mortgages, credit card debt and student loans, and disclose their findings to investors. If the bank’s review reveals that the underlying loans did not satisfy the underwriting standards promised to investors, the banks must disclose that finding in a filing.
If you have investment losses or problems involving asset backed securities, call the lawyers at Page Perry for experienced representation at (404) 567-4400 or (877) 673-0047 (toll free).