Subprime Mortgage Credit Derivatives

CHAPTER 5

Subprime Triggers and Step-Downs

In this chapter, we review the basics of subprime triggers and step-downs, two distinguishing features of the excess spread/overcollateralization (XS/OC) structure. We also review the last few vintages of subprime deals that passed their step-down dates, and summarize the effect of the step-down and associated triggers on those deals.

THE STEP-DOWN AND THE TRIGGER

Almost all subprime deals contain a step-down provision. Step-down refers to conversion of deal structure from sequential pay to pro rata pay. There are three direct implications of the step-down:

1. End of principal lockout for all bonds below AAA (the mezzanine, subordinated, and OC tranches).
2. Reduction of subordination to poststep-down target levels.
3. Release of principal to all mezzanine, subordinated, and OC tranches (OC release).

While the terms subordinated (sub) and mezzanine (mezz) have no standard definition, in this chapter we refer to all investment grade support bonds below AAA as mezzanine bonds and all noninvestment grade support bonds below AAA as subordinated bonds.

In the first 36 months (the “lockout period”), all tranches other than the seniors are locked out and do not receive principal payments (unless the seniors have paid down completely, which we discuss here). By the step-down date (almost universally set 37 months from the deal's closing date), the deal collateral is sufficiently seasoned that its performance may be tested. If the aggregate collateral ...