Introduction to Securitization

SELECTING THE PAY-DOWN STRUCTURE FOR THE BOND CLASSES

The credit enhancement structure is a decision that is made at the inception of the transaction. The liability structure, however, changes over time depending on the pay down structure that is selected by the securitizer. The pay-down structure is the rules that deal with how the principal generated by the asset pool will be distributed to the bond classes when the liabilities are amortized over time.²⁷ In turn, it affects the capital structure of the transaction at different points in time, and therefore the weighted average cost of the structure. So, the pay-down structure decision can be almost as important as the credit enhancement structure decision made at the outset of the transaction.

There are four general types of pay-down structures with combinations thereof:

• Sequential

• Pro rata

• Fast-pay/slow-pay

• Step-up

 

In a sequential pay-down structure, the bond classes are paid down sequentially, highest credit rated bond class down to the unrated bond class. For our hypothetical five-bond class structure, this means first paying off bond class A and paying nothing to any of the other four bond classes. Once bond class A is completely retired, all principal payments are made to bond class B until it is fully retired and so on with bond classes C, D, and E.²⁸ Effectively, a sequential pay-down structure of the liability classes reduces the leverage in the structure because it is the higher rated classes that are ...