Introduction to Securitization

TARGETED AMORTIZATION CLASS BONDS

In certain market environments, institutional investors may be concerned more with one type of prepayment risk, say contraction risk, rather than the other type (extension risk). To accommodate investors with such concerns, a bond class known as a targeted amortization class bond (TAC bond) was developed. A TAC bond resembles a PAC bond in that both have a schedule of principal repayment. The difference is that in structuring a PAC bond, a relatively wide structuring band (i.e., PSA range) is used in order to provide protection against both contraction risk and extension risk. In contrast, a TAC bond has a single prepayment speed from which the schedule of principal repayment is protected. As a result, the prepayment protection provided to investors in a TAC bond is less than for PAC bond investors and results in protection against contraction risk but not extension risk. Hence, while PAC bonds are said to afford an investor two-sided prepayment protection, investors in TAC bonds are provided one-side prepayment protection.

TAC bond have been used in different ways in structures. TAC bonds are used in some deals as an alternative to PAC bonds and given the highest cash flow priority within the deal. In other deals, a TAC bond is carved out of a support bond in order to give it better protection from contraction risk than a standalone support bond.