Introduction to Securitization

TIME TRANCHING OF BOND CLASSES

The determination of the bond classes in a structure with the same level of credit priority is nothing more than time tranching. In our illustration of agency CMOs, we demonstrated the time tranching for the purpose of creating bond classes that are more attractive to institutional investors and thereby reducing the weighted average cost for the transaction, particularly in an upward sloping yield curve environment.

What is done in agency CMOs with respect to time tranching can in principle be done for the senior, mezzanine, and subordinated bond classes in a nonagency deal. However, in practice, only the senior most bond classes are time tranched. For example, in our hypothetical structure above, bond class A might be time tranched. For example, a sequential-pay structure with say bond classes A-1, A-2, and A-3 can be created. In this case, all the principal that would be distributed to bond class A in our hypothetical structure would be distributed to bond class A-1 until that bond class is retired. Then all the principal that would be distributed to bond class A would go to bond class A-2 until it is retired. Finally, bond class A-3 receives all the principal that would have gone to bond class A. How many such bond classes are created is a question of the yield differences and investor preferences for senior bond classes of different durations. Typically, there is at least one bond class that pays off in just one year in order to qualify that ...