Pay-through Structures: Prepayment Tranching vs. Credit Tranching
Asset-backed securities can be issued as pass-through or pay-through securities.
ABS Pass-through Structure: In a pass-through structure, the cash flows generated by the asset pool are passed through to investors, less a servicing fee, on a pro-rata basis (this is the same general structure as that of the mortgage pass through securities previously discussed).
ABS Pay-through Structure: This is similar to a collateralized mortgage obligation, where tranches with different characteristics are paid out differently based on their risk-return profile.
The tranching within a pay-through structure can be of two types: credit tranching and prepayment tranching. Tranching is a type of internal credit enhancement.
Two Types of Pay-through Structures
- Credit Tranching: This is the most common form of tranching and creates a senior/subordinate structure. A typical senior/subordinate structure consists of several tranches varing in their seniority. Cash flows are divided among senior and subordinated tranches. The senior tranches are the first ones to be paid the principal from the available cash flow. Subordinate tranches are the first to absorb default losses, so the subordinate tranches provide protection to the senior tranches. This protection structure is also called waterfall structure. The structure redistributes credit risk and is considered a credit enhancement.
- Prepayment Tranching: Cash flows are divided among tranches that have different principal payment parameters. These tranches can be sequential pay or planned amortization class, for example. This structure redistributes prepayment risk. The senior tranche is divided into tranches with different exposure to prepayment risk. In this way, senior tranches can be transferred among the senior tranches.
- Collateralized Mortgage Obligations (CMO) and CMO Tranches
- Stripped MBS – Interest Only (IO) and Principal Only (PO)
- Residential Non-Agency MBS
- CMBS: Structure and Call Protection
- Amortizing Loans vs. Non-Amortizing Loans
- Overview of Asset Backed Securities (ABS)
- Internal and External Credit Enhancements
- Pay-through Structures: Prepayment Tranching vs. Credit Tranching
- Home Equity Loans (HEL) Backed Securities
- Manufactured Housing Backed Loans
- Auto Loans Backed Securities
- Student Loan Backed Securities (SLABS)
- SBA Loan Backed Securities
- Credit Card Receivable Backed Securities
- Collateralized Debt Obligations (CDOs) and Synthetic CDOs
- Cash Flow Yield, Nominal Spread, and Zero Volatility Spread for ABS/MBS
- Monte Carlo Simulation for ABS/MBS
- CFA Level 2: Fixed Income Part 2 – Introduction
- Duration and Convexity for ABS/MBS
- Mortgage Cash Flow Characteristics
- Choosing an Appropriate Spread for ABS/MBS
- Mortgage Pass-through Securities: Characteristics and Risks
- Cash Flows and Prepayment Risk
- Single Monthly Mortality (SMM) & Conditional Prepayment Rate (CPR)
- PSA Prepayment Benchmark
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