An Asset-Backed Security (ABS) is a security instrument whose income payments and hence value is derived from and collateralized (or “backed”) by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets which are unable to be sold individually. Pooling the assets into financial instruments allows them to be sold to general investors; a process called securitization, and allows the risk of investing in the underlying assets to be diversified because each security will represent a fraction of the total value of the diverse pool of underlying assets. The pools of underlying assets can include common payments from physical assets as well as intangible assets such as credit card payments, auto loans, and mortgage loans, to esoteric cash flows from aircraft leases, royalty payments and movie revenues.

In many cases, a separate institution called a special purpose vehicle is created to handle the securitization of asset backed securities. The special purpose vehicle, which creates and sells the securities, uses the proceeds of the sale to pay back the bank that created, or originated, the underlying assets. The special purpose vehicle is responsible for “bundling” the underlying assets into a specified pool that will fit the risk preferences and other needs of investors who might want to buy the securities, for managing credit risk – often by transferring it to an insurance company after paying a premium – and for distributing payments from the securities. As long as the credit risk of the underlying assets is transferred to another institution, the originating bank removes the value of the underlying assets from its balance sheet and receives cash in return as the asset backed securities are sold, a transaction which can improve its credit rating and reduce the amount of capital that it needs. In this case, a credit rating of the asset backed securities would be based only on the assets and liabilities of the special purpose vehicle, and this rating could be higher than if the originating bank issued the securities because the risk of the asset backed securities would no longer be associated with other risks that the originating bank might bear. A higher credit rating could allow the special purpose vehicle and, by extension, the originating institution to pay a lower interest rate (and hence, charge a higher price) on the asset-backed securities than if the originating institution borrowed funds or issued bonds.

Thus, one incentive for banks to create securitized assets is to remove risky assets from their balance sheet by having another institution assume the credit risk, so that they (the banks) receive cash in return. This allows banks to invest more of their capital in new loans or other assets and possibly have a lower capital requirement.

Securitization is the process of creating asset-backed securities by transferring assets from the issuing company to a bankruptcy remote entity. Credit enhancement is an integral component of this process as it creates a security that has a higher rating than the issuing company, which allows the issuing company to monetize its assets while paying a lower rate of interest than would be possible via a secured bank loan or debt issuance by the issuing company.

Asset backed securities provide originators with the advantage of selling these financial assets to the pools, which reduces their risk-weighted assets and thereby frees up their capital, enabling them to originate still more loans. Asset-backed securities also lower the originators risk. In a worst-case scenario where the pool of assets performs very badly, the owner of ABS (which is either the issuer, or the guarantor, or the re-modeler, or the guarantor of the last resort) might pay the price of bankruptcy rather than the originator.

Milton and Cross Commercial Solicitors provides individuals and businesses with legal due diligence and transactional advisory services when structuring, purchasing, or divesting asset backed assets or their derivatives. We also provide trainings to In-house counsel, transaction teams, and investment advisors on these transactions. Please feel free to call us on +2348036258312 or email us at miltoncrosslexng@gmail.com.


The introduction and exploitation of new ideas, the source of all major growth, requires considerable capital investment. Consequently, the degree to which an organization will develop is highly dependent upon its ability to marshal and direct a consistent flow of external funds towards the development and marketing of new products and services. This is the concept of using OPM (Other Peoples Money).

The Pecking order theory of financial management states that all things being equal, a company with high prospects of success is more likely to finance its investment projects using internally generated capital, followed by debt finance (mortgages, debentures), and finally equity based financing (common stock, preferred stock). This is premised on the view that the company would be able to generate sufficient income from the project to refund the monies borrowed and the interest thereon.

However the ability of a firm to invest in new projects is directly tied to its cost of capital; that is, the interest rate at which the organization may raise finance from a bank or financial entity. As a general rule, the higher the risk free interest rate, which is the interest rate at which 3-Month Treasury Bills are sold in the money market, the higher the cost of capital within the economy.

Look at it this way, if a bank could receive a sure return of 10% per annum by investing its funds in Treasury bills, wouldn’t it require a higher rate of return from a prospective borrower who presents a substantially riskier project? Banks are assumed to be risk averse, and consequently they are likely to penalize borrowers for each additional unit of risk in the form of increased interest rates.

Money is expensive and when we look at balance sheets of Nigerian companies it becomes readily evident that the cost of loans is a growing problem. A high cost of capital has the effect of stifling innovation and often leads to capital flight and domestic unemployment, as companies seek greener economies with more favourable costs of capital.

Fortunately, alternative means of finance presently exist which seek to circumvent the high costs of capital imposed by banks (who by the way need to finance their high overheads by charging high interest rates on loans to customers). These means include Peer to Peer Business lending, SME financing programs (especially for entrepreneurs in the agricultural space), Soft loans and Business support grants from non governmental organizations. Furthermore, most states have in place business empowerment programs which provide low interest finance to entrepreneurs who have viable business plans.

The concept of using OPM still exists, but unless management can objectively justify the assumption of debt, it is advisable that the use of debt financing be minimized whensoever Treasury bill yields are high. It is also advisable that firms invest in Capital projects designed to boost its revenue base, as opposed to revenue expenditure, which only serves to deplete the organization’s capital base.

If you feel you need to discuss options for capitalisation of your business, feel free to discuss with one of our consultants by calling +2348036258312 or send and email to miltoncrosslexng@gmail.com and someone will get back to you.