Modeling Structured Finance Cash Flows with Microsoft® Excel®: A Step-by-Step Guide

CHAPTER 6

Liabilities and the Cash Flow Waterfall

With asset generation complete, this book now turns to the liability side of the model. While the asset side is fairly standard for a level payment amortization, the liability section can vary greatly depending on the unique structure of the transaction. Due to the variability between deals, the liability side needs to be constructed with as much flexibility as possible. This is achieved by breaking down the liabilities into individual components that work similarly and can be moved around quickly.

Before going into the mechanics of how liabilities are paid, it should be understood what constitutes a liability. For a structured transaction, any cost that is to be paid from the cash generated by the assets is a liability. Foremost are costs, which keep the transaction in existence such as trust, servicer, and rating agency fees. Next is interest and principal due to the parties who funded the assets. This section can be very complicated depending on the different risk classes of debt known as tranches. The method in which these tranches are returned principal can also vary between transactions and as will be seen in the next chapter, within a transaction.

PRIORITY OF PAYMENTS AND THE CASH FLOW WATERFALL

In actual transactions, how the liability structure functions is dictated by the priority of payments section of a term sheet. This section is often referred to as a waterfall because the available cash starts at the top and then ...