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

CREDIT ENHANCEMENT FOR MORTGAGE ABS DEALS

As noted above, mortgage ABS credit enhancement utilizes a combination of subordination, excess spread, OC, and derivatives. The structure ultimately utilized for any particular deal is a function of (1) the attributes of the collateral; and (2) the amount of enhancement necessary to secure the desired ratings on different bonds from the rating agencies. In addition to the utilization of excess spread and OC, there are a few differences between subordination in the prime and ABS sectors. The mechanism for growing ABS subordinates as a portion of the deal and allocating principal to the subordinates differs somewhat from the shifting interest mechanism in residential structures. In addition, ABS subordinates are typically not structured to create as many low-rated subordinates as residential deals. As described in the previous chapter, prime deals have a “six-pack” of subordinates, with the lowest tranche in the credit spectrum being an unrated first-loss piece. ABS deals are generally structured down to the triple-B-minus level, although some deals are structured with subs rated as low as double B. In these deals, the excess spread and the residual serve as the first-loss components.

As previously noted, OC can be created at issuance (by structuring initial OC) or generated over time by utilizing excess spread to turbo the deal. In either case, the deal will have a target OC amount, which is the OC (as a percentage of the face value ...