CHAPTER 4
Liabilities
Froth at the top, dregs at bottom, but the middle excellent.
—Voltaire
4.1 GETTING STARTED
The liabilities in a “cash” securitization are the bonds issued to investors (the debt holders) to raise cash to buy the asset portfolio. Review Figure 1.2 sketching a mortgage securitization. This chapter describes how to model the liability cash flows, that is, payments of interest and principal to debt holders. These cash flows are crucial to valuing or pricing the bonds.
The model described accommodates alternative liability structures and their controls, known as priorities of payment or waterfalls. A general liability structure is comprised of tranches or classes. Some tranches may be kept on the books of the seller/securitizer. However, most tranches correspond to bonds or notes that are sold to investors. Generally, bonds promise (fixed or floating) interest and principal payments each period. However, the aggregate periodic payment is not fixed as in mortgage loans. In addition, a bond might be guaranteed by a third-party insurer. In this case, payments cannot be late or lost, unless the guarantor defaults. If a bond is not guaranteed, then there is the chance that a bond payment is late or lost because an asset defers interest or defaults. Still, the servicer may agree to advance missing payments to the extent deemed recoverable, to be potentially reimbursed by later, excess cash flows.
Tranches are broadly categorized as senior or subordinate, corresponding ...
