Asset Backed Securities (ABS) are financial securities backed by a pool of assets that produce income, generally loans. In the case of Mortgage Backed Securities (MBS) and Commercial Mortgage Backed Securities (CMBS), the underlying assets are, respectively, residential and commercial mortgages. However, unlike MBS, asset backed securities are backed by non-mortgage loans, including auto loans, student loans, credit card debt, and variety of other types of debt. Therefore, it could be argued that the structural differences between ABS, MBS, and CMBS are mostly superficial-- it is only the exact type of loan that changes.

In general, to create an mortgage backed security, like a CMBS, the initial lender will sell the loans to a trust, which is typically set up as a special purpose entity (SPE), or special purpose vehicle (SPV), in order to pool the loans together and issue them to investors. Other major creators of MBS products include Ginnie Mae (the Government National Mortgage Association), which securities government-insured loans, including many HUD/FHA-insured single-family and multifamily loans. Other prominent MBS issuers include Fannie Mae and Freddie Mac which are both GSEs (government-sponsored enterprises).

In a similar fashion, asset backed securities also are created by pooling assets into a trust. For instance, a credit card company, such as Capital One, will pool unpaid credit card debt into a trust, which will issue semi-regular payments to investors who purchase shares. The same can be said for auto loans, student loans, and other loan products that are securitized into ABS.

The main advantage of Asset Backed Securities (ABS) over Commercial Mortgage Backed Securities (CMBS) is that ABS are backed by a variety of non-mortgage loans, such as auto loans, student loans, and credit card debt. This allows investors to choose from a wider range of investments and potentially achieve a higher yield on their investments. Additionally, ABS have more flexible underwriting guidelines than CMBS, which can make them more attractive to investors.

Sources:

• cmbs.loans/blog/abs-vs-cmbs
• apartment.loans/posts/cmbs-explained

CMBS loans offer several advantages over ABS loans, including:

• Flexible underwriting guidelines
• Fixed-rate financing
• Fully assumable
• Lenders and bondholders can potentially achieve a higher yield on investments
• Investors can choose which tranche to purchase, allowing them to work within their own risk profiles
• Non-recourse
• Attractive fixed rates for long term loans
• Can go up to 75% LTV
• Wide range of loan sizes
• Will consider non-Class “A” assets
• Less scrutiny for borrowers
• Provides cash out refinancing
• Loans are fully assumable
• Can be combined with mezzanine debt or preferred equity in many scenarios

Sources: cmbs.loans/blog/abs-vs-cmbs, apartment.loans/posts/cmbs-explained, www.multifamily.loans/multifamily-cmbs-loans

The risks associated with ABS and CMBS are mostly related to the underlying assets that are used to back the securities. For ABS, the risks are related to the non-mortgage loans, such as auto loans, student loans, and credit card debt. These loans can be more difficult to manage and can be more prone to default. For CMBS, the risks are related to the underlying mortgages, which can be more difficult to manage due to the complexity of the loan terms and the potential for default.

In addition, both ABS and CMBS can be divided into tranches based on risk, with certain tranches offering lower potential returns and higher risk, and other tranches offering higher potential returns and lower risk. Dishonest tranche ratings can have serious negative effects for borrowers and investors.

Other risks associated with CMBS include not being serviced by the initial CMBS lender, strict enforcement of prepayment penalties, and higher closing costs.

The benefits of investing in ABS and CMBS include:

• Flexible underwriting guidelines (CMBS)
• Fixed-rate financing (CMBS)
• Fully assumable (CMBS)
• Lenders and bondholders can potentially achieve a higher yield on investments (CMBS)
• Investors can choose which tranche to purchase, allowing them to work within their own risk profiles (CMBS)
• The ability to invest in a variety of loan products, such as auto loans, student loans, credit card debt, and other types of debt (ABS)
• The ability to invest in semi-regular payments (ABS)