Sub-prime refers to loans or receivables that are made to borrowers with lower credit ratings. These borrowers are considered to be more likely to default on their loans, so sub-prime loans typically have higher interest rates than prime loans.
Sub-prime loans are often securitised, which means that they are pooled together and sold as securities. This allows investors to buy a share of the pool of loans, and to receive payments based on the interest and principal payments made by the borrowers.
Sub-prime securitisations can be used to provide funding for a variety of purposes, including:
- Mortgages: Sub-prime securitisations are often used to finance sub-prime mortgages. These mortgages are made to borrowers with lower credit ratings, who may not be able to qualify for a prime mortgage.
- Auto loans: Sub-prime securitisations can also be used to finance sub-prime auto loans. These loans are made to borrowers with lower credit ratings, who may not be able to qualify for a prime auto loan.
- Credit cards: Sub-prime securitisations can also be used to finance sub-prime credit cards. These cards are issued to borrowers with lower credit ratings, who may not be able to qualify for a prime credit card.
Sub-prime is sometimes referred to as "specialist" or "non-conforming".
Here are some of the risks associated with sub-prime securitisations:
- Higher default rates: As mentioned above, sub-prime borrowers are more likely to default on their loans than prime borrowers. This means that sub-prime securitisations are more likely to suffer losses.
- Market volatility: Sub-prime securitisations can be more volatile than prime securitisations. This is because the value of the underlying loans is more sensitive to changes in interest rates and other market conditions.
- Regulatory risk: Sub-prime securitisations are subject to a variety of regulations, which can change over time. This can make it difficult to predict the future performance of sub-prime securitisations.