Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques

CHAPTER 9

The Structuring of Mortgage ABS Deals

In the prior chapter, we noted that the emphasis in structures in the mortgage ABS sectors is different from that in structures involving prime first-lien residential loans. Loans that fall into the general category of mortgage ABS are riskier than those in prime deals, either because the loans are granted to borrowers with impaired credit (which greatly increases their expected defaults and losses) or are in an inferior lien position (which creates high-loss severities). As such, these loans are characterized by higher note rates than those in the prime first-lien sector, reflecting risk-based pricing on the part of lenders.

The challenge in structuring mortgage ABS deals is to create cash flow protection and credit enhancement for the senior securities in the most efficient possible way. The optimal form of credit enhancement for deals backed by risky loans with high note rates is the overcollateralization (OC) structure, introduced in Chapter 5. This structure allows the higher note rates associated with these riskier loans to be converted into credit enhancement. In addition to the utilization of excess spread as credit enhancement, deals securitizing these types of risky loans must have higher levels of subordination than shifting interest structures in the prime sector. While this chapter primarily addresses mortgage ABS deals, our objective is to explore the mechanisms associated with the OC structure, as they are more ...