Coffee Break Session:
What Is Asset-Backed Debt?
What is asset-backed debt? Coffee Break Session Host Jason Campbell catches up with Strategic Treasurer’s Senior Advisor, Paul Galloway, to discuss how asset-backed debt is used for raising capital, the different types of issuances, why a company would issue an asset-backed instrument, and the risks. Listen in and learn a little bit about asset-backed debt.
Jason Campbell, Strategic Treasurer
Paul Galloway, Strategic Treasurer
Episode Transcription - (Coffee Break Session Series) - Episode 75 - What Is Asset-Backed Debt?
Jason Campbell 00:03
Welcome to the Treasury Update Podcast, Coffee Break Sessions presented by Strategic Treasurer covering foundational topics and core treasury issues in about the same amount of time it takes you to drink your cup of coffee. I’ll be your host Jason Campbell, business development leader at Strategic Treasurer. Alright, welcome to another episode of Coffee Break Sessions, we’re going to talk about asset backed debt, you know, as part of a series that we’ve been talking about raising capital, going to talk about another great subject here. And again, speaking with me today is we should probably just call him Dr. of Finance or Dr. of Investing because man, he is just so like an encyclopedia of knowledge here. So and I’m always thankful to have the opportunity to talk with our Senior Advisor here at Strategic Treasurer, Paul Galloway. Paul, welcome back to the show.
Paul Galloway 00:48
Yeah, thanks. Thanks for having me back. Jason.
Jason Campbell 00:51
I mean, it’d be bad if I called you like, Doc, can I call you like Dr. Paul? Would that be good? Are you like, . I’m gonna stick with Paul.
Paul Galloway 00:58
I’m good with whatever I’m flexible.
Jason Campbell 01:01
You’re gonna, whatever you want to call it right? It’s all good. Let’s kick it off here and just go right into what is exactly what is asset backed debt?
Paul Galloway 01:09
Yeah, I’ll try to keep this in its simplest terms, because this type of issuance is really pretty unique. But in its simplest form, what asset backed debt is, is you’re have a you have a company that is simply wanting to purchase a book or pool of assets. And what they do is they issue debt. And simultaneously, they go out, and they buy the assets. That’s an asset that.
Jason Campbell 01:37
I think was like, a couple episodes ago. And I was thinking to myself, you know, when we think of debt, we think of it as being a bad thing. But in situations where a company can really take advantage of selling off debt itself. And raising capital, that way is such a unique concept. And I can see it on both sides. And, and so these past couple episodes that we’ve gone through, just made me really kind of open my eyes to these other concepts of raising capital versus just your traditional thinking. So pretty interesting. So as we talk about that piece of what asset backed debt is, what are the different types of asset backed debt issuances? Are there?
Paul Galloway 02:12
Yeah, that’s a, that’s a great question. Generally, it’s kind of just overall one type of type of structure. But what the issue is, what makes it different is the types of assets that are backing the debt. That’s what makes the types difference, because so you can have a set of assets that are mortgage loans or residential mortgage loans. So they call that our RMBs. It’s the same thing as abs. asset backed security as ABS RMBs is residential mortgage backed security, they’re different types of issuance because of what’s backing the issuance. So you’ll see auto loans, aircraft leases, corporate loans, credit card debt, residential mortgage, as I mentioned, are, those are some of the typical types that you’ll see for any type of asset backed issuance.
Jason Campbell 03:16
You know, it’s funny, go back and think of childhood and I think of my parents, you know, and the things that we would say, as kids, my, my siblings, and I, and the things that you’re, as, you know, like that progressive commercial that says, you know, you becoming your parents, right. And I know that like, at times, like my kids, you brought up a couple of interesting points. And my kids are like, Well, Dad, you know, we own our house, I’m like, No, we don’t own the house, the mortgage company who, you know, they own the house, we pay them off until, you know, the debt is paid for, right, which is goes back to be an asset deck, you know, asset backed debt, or a vehicle as you said, Well, it’s our car. Well, technically, it’s not until it’s if you finance it, and you know, the bank or whoever, you know, whoever did the financing for you is the actual owner of the asset, you’re paying it off to them until you pay it off your day, you will be the sole sole owner of your of your asset, right. So it’s an it’s an interesting piece. And I find myself talking to my children that same exact way as I start to teach them a little bit about finance. So it’s, you know, it’s, that’s a great example that you you pulled up, so I appreciate you kind of hitting on that. And that’s just what first thing that came to mind as a parent. Now, why would a company issue an asset backed instrument?
Paul Galloway 04:26
Typically what’s happening is the organization is looking to buy a book or pool of assets that they believe they can fund the purchase by issuing debt and get a better return than what’s going to be owed on the debt instrument that’s issued the back that is issued. What they do is they create what’s called like a SPV or special purpose vehicle that acts as the conduit for the issuance of debt. And that vehicle will be the issuer of the debt and the purchaser of the assets. And what the company’s betting on is, the cash flows tied to those assets are going to be greater the cash flows that they have to pay for the debt, it’s a spread game is really what it is. They think they can beat the spread. Companies do this all the time, there’s all kinds of asset backed securities are out there. It’s all tied to what the organization that is purchasing the pool of assets and issuing the debt, same time, things that they can do.
Jason Campbell 05:42
You know, it’s funny, you said, you know, the beat the spread, and I kept thinking about was, you know, like a Vegas sportsbook room, you know, because it’s football season, and that’s what’s the spread, what’s the spread, you hear, right? So that’s why first thing that came to mind was just thinking of, you know, some casino somewhere, you know, somebody’s screaming out, beat the spread, so, but I could, I could totally see that the same thing that that gamble piece of it. So what risk if any, are associated with this type of issuance?
Paul Galloway 06:05
The risks associated with it can be, you know, tick auto loans, or credit card debt, or any of those examples I gave mortgages and so forth, is that the cash flows, the underlying cash flows associated with the purchase of those assets, don’t pan out to be what the organization expects, it’s going to be meaning that there’s more bad debt write offs than what was expected. So your cash flows shrink, because you’re writing off bad debt, you know, or people are defaulting on their payments for their mortgages. corporations don’t have cash flow to pay any of these instances where there’s a risk that the cash flow doesn’t pan out to be what you expect. So then, cash flow shrinks in totality, and the margin or the spread that you think you’re going to earn, shrinks along with it. And so you’re trying to mitigate those risks as much as you can. The key is, is that the organization that’s going to issue the debt and buy the assets really has to do good due diligence on the underlying cash flows and make sure that they understand what’s going on there.
Jason Campbell 07:22
So thank you for joining me today. Paul. Again, always love hearing your insights and perspective and just taking me to school on these are all topics related to treasury and finance. And for our listeners, please be sure to tune in every first and third Thursday of the month for a new episode of the Coffee Break Sessions. As usual. If you have any questions, comments or feedback, please send us a note at podcast@StrategicTreasurer.com. Until next time, take care.
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A part of the Treasury Update Podcast, Coffee Break Sessions are 6-12 minute bite-size episodes covering foundational topics and core treasury issues in about the same amount of time it takes you to drink your coffee. The show episodes are released every first and third Thursday of the month with Host Jason Campbell of Strategic Treasurer.