Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques, 2nd Edition

CHAPTER 9

The Structuring of Mortgage ABS Deals

In the previous chapter, we noted that the emphasis in structures in the mortgage ABS sectors is different from that in structures involving prime first-lien residential loans. Loans that fall into the general category of mortgage ABS are riskier than those in prime deals, either because the loans are granted to borrowers with impaired credit (which greatly increases their expected defaults and losses) or are in an inferior lien position (which creates high-loss severities). As such, these loans are characterized by higher note rates than those in the prime first-lien sector, reflecting risk-based pricing on the part of lenders.

As with other types of private-label deals, the challenge in structuring mortgage ABS transactions is to create cash flow protection and credit enhancement for the senior securities in the most efficient possible way. The optimal form of credit enhancement for deals backed by risky loans with high note rates is the overcollateralization (OC) structure, introduced in Chapter 5. These structures allow the higher note rates associated with riskier loans to be converted into credit enhancement. Our primary objective is to explore the various mechanisms associated with the OC structure, which by necessity are more complex than the simpler shifting interest structures utilized in the prime sector and discussed in Chapter 8.

For the purposes of this chapter, mortgage ABS deals are also simply referred to as ABS deals. ...