Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques

PLANNED AMORTIZATION CLASSES (PACS) AND THE PAC/SUPPORT STRUCTURE

The PAC/Support structure is designed to create mortgage bonds that have reduced exposure to prepayment risk and cash flow uncertainty, and creates securities targeted to appeal to buyers of bullet structures such as corporate bonds. The structuring process involves dividing the available cash flows within a deal into two or more groups, and assigning one group priority in receiving scheduled amounts of monthly principal payments from the collateral. The result is that the prioritized group (and bonds tranched from it) has average lives, durations, and cash flow windows that are constant within a predesignated range of prepayment speeds. The bonds that are lower in priority, however, have increased cash flow volatility, and typically trade to higher yields to entice investors.

The actual process of structuring PACs involves the following steps:

1. Designating the range of prepayment speeds within which the classes will (at issuance) have unchanged principal cash flows (known as the PAC band or PAC collars).

2. Generating a schedule of principal payments, using the speeds chosen as the upper and lower limits of the PAC band.

The PAC band at issuance (which is sometimes designated as the “structuring band”), is generally chosen at a range of prepayment speeds above and below the expected prepayment speed of the collateral, given the prevailing interest rate environment. In agency deals, the lower band (quoted ...