Introduction to Structured Finance

CHAPTER 5

Securitization Structures

We provided the basics of securitization in the previous chapter. In this chapter, we discuss securitization structures and the use of interest rate derivatives in a securitization.

USE OF INTEREST RATE DERIVATIVES IN SECURITIZATION TRANSACTIONS¹

Chapter 2 reviewed derivative instruments. In this section, we explain the use of interest rate derivatives in securitization transactions for hedging and yield enhancement. Three types of over-the-counter interest rate derivatives commonly used in securitizations are interest rate swaps, interest rate caps, and interest rate corridors. Because they are over-the-counter instruments, they expose the trust (the special-purpose vehicle (SPV)) to counterparty risk.

Interest Rate Swaps

An interest rate swap can be used to alter the cash flow characteristics of the assets (liabilities) to match the characteristics of the liabilities (assets). For example, suppose a transaction has a pool of fixed-rate, monthly payment loans but the bond classes that are supported by the collateral have floating rate, monthly payment characteristics. A generic or plain vanilla swap can be used to convert the monthly, fixed-rate cash flows to monthly, floating-rate cash flows based on the reference rate and margin owed to the covered classes of bonds. For example, the prospectus supplement of the Toyota Auto Receivables 2003-B Owner Trust, $554,000,000 Floating Rate Asset Backed Notes, Class A-3 states:

In order to issue the ...