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

FLOATER/INVERSE FLOATER COMBINATIONS

As with many structuring techniques, floater/inverse floater (or “inverse”) combinations can be structured from a variety of cash flows, including the entire collateral pool. The objective in creating floater/inverse combinations is to improve deal execution by taking advantage of the very low yields associated with floating rate bonds, especially when the yield curve is steep. Creating floating rate bonds (i.e., bonds where the coupon changes periodically based on an index) from fixed rate underlying cash flows also implies the creation of a bond where the coupon changes inversely with the floater coupon (and thus the index), known as the inverse floater. In agency and private label deals, the inverse floater is structured as a separate tranche that mimics the principal cash flow profile of the underlying bond. The coupon, however, changes inversely with the change in the index and thus the floater coupon, since interest available to be paid to the inverse is limited by the interest paid to the floater.

There are several noteworthy aspects to structures that include floating rate bonds:

• Early in the inception of such deals, floater deals did not incorporate inverse floaters as tranches. Rather, the inverse floating rate coupon was sold as part of the residual interest.

• Once structured, both floaters and inverses can be treated as parent bonds and retranched, creating highly complex structures.

• Floating rate mortgage ABS structures ...