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Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques by WILLIAM S. BERLINER, ANAND K. BHATTACHARYA, FRANK J. FABOZZI

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FACTORS INFLUENCING THE CREDIT STRUCTURE OF DEALS

As with residential deals, rating agencies play a key role in determining the credit enhancement required for a deal. In prime deals, the rating agencies decide the levels of subordination needed to allow the bonds in the structure to attain the desired rating, based on the attributes of the collateral pool. In addition to the subordination levels, the rating agencies also consider other factors in rating the components of an ABS deal. These include:
• The correct level of target OC needed to adequately protect the bonds in the deal.
• Whether the OC target can be met through excess spread based on realistic assumptions.
The structuring decisions required to garner desired ratings are based on a number of interacting considerations. Under normal circumstances, losses are not expected to begin accumulating until the collateral has seasoned by 12 to 24 months, mitigating the need for initial OC. However, the rating agencies may require initial OC for a specific deal based on either collateral- or bond-specific factors. Some examples might include the following:
• If the rating agencies believe that the excess spread on risky loans is not sufficient enough to build OC in time to meet the target OC level, initial OC may be required in the deal.
• A larger proportion of longer hybrids (e.g., 3/27s instead of 2/28s) results in higher available funds cap risk. In turn, the amount of excess spread available to turbo the bonds is potentially ...

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