Introduction to Securitization

DETERMINATION OF THE BOND CLASSES

The decision of the bond classes to be included in a transaction (or equivalently the classes of liabilities) involves establishing the priority order of the different bond classes. The bond classes include senior, mezzanine, and junior classes. This decision is related to the credit enhancement decision because the liabilities are part of the credit enhancement structure. The key factor to be considered is what credit support level is required to protect the most senior bonds in the structure. As noted earlier, the key in subprime structures is protecting the senior bonds. Another factor is obviously what is the lowest-rated bond class that can be sold in the market.

To illustrate the structuring of the bond classes, let us assume that the securitizer has the following information:

• Investment bankers indicate that the lowest-rated bond class that can be sold is triple B (BBB).

• The rating agency that will rate the bonds indicated that the level of support required to achieve the following ratings is:

Consider first the most senior bond class to be issued with a triple A rating and which we refer to as bond class A. Absent any other credit support, since an 8% credit support is required, this means that bond class A can only be 92% of the size of the transaction. For example, if the pool of assets is $500 million, only $460 million of bond ...