SEQUENTIAL PAY STRUCTURES
We begin with the simplest form of time tranching of the collateral in order to create bond classes in a transaction that will have average lives and durations that will appeal to a wider range of investors than the collateral itself. To see this, we will use the $660 million, 5.5% pass-through security (which is comprised of residential mortgage loans that confirm to the underwriting standards of Ginnie Mae, Fannie Mae, and Freddie Mac) to create a simple structure. The structure is given below and we refer to this structure as “Structure 1.”
In structuring an agency deal, there are only rules specified for the distribution of principal and interest. There are no rules for deals with defaults and delinquencies because payments are guaranteed by the issuer. In Structure 1 we will use the following rules:
• Interest. The monthly interest is distributed to each bond class on the basis of the amount of principal outstanding at the beginning of the month .
• Principal. All monthly principal (i.e., regularly scheduled principal and prepayments) is distributed first to bond class A until it is completely paid off. After bond class A is completely paid off its par amount, all monthly principal payments are made to bond class B until it is completely paid off. After bond class B is completely paid off its par amount, all monthly principal payments are made ...