Advanced Liability Structures
Triggers, Interest Rate Swaps, and Reserve Accounts
Loss protection is the single most important reason for advanced liability structures. All entities that fund transactions are worried about loss and try to anticipate and protect against its different forms. As seen from Chapter 4, nonperforming assets that have stopped generating cash and are considered delinquent or defaulted cause loss. However, there can also be structural issues such as interest rate mismatches, which need some type of protection. Advanced liability structures such as triggers, swaps, and reserve accounts are created to help prevent and mitigate these concerns.
TRIGGERS AND THEIR AFFECT ON THE LIABILITY STRUCTURE
The simplest and most cost-effective method of mitigating loss is by altering the structure of the transaction when problems arise. If a deal is performing as expected, then the liability structure is probably sufficient to ensure that all parties are repaid. However, when assets begin to default, investors worry and become very cognizant of where they stand in the priority of payments. In many structured transactions, a senior investor will have negotiated a change in the priority of payments if the deal begins to perform very poorly. The change is usually caused by a predefined test, officially known as a trigger, being breached. This change directs more cash to the senior investor so that the senior obligation receives principal faster.
The speed ...