Appendix II: ABS payment structures.

Author:Jobst, Andreas A.
Position:Collateralised Loan Obligations (CLOs - Asset backed securities

We need to equally privilege different structures of asset-backed securities, i.e. the relationship of the maturity of the underlying assets, on the one hand, and method of cash flow management and the ways of scheduled repayment of principal and interest of the underlying reference portfolio to investors, on the other hand. The following section provides a basic description, and working definition of transaction payment structures.

Securities that return total principal to investors throughout the life of the security are considered fully amortising, where the securitised portfolio generally consists of assets, such as car loans, manufactured housing contracts or other fully amortising assets. Controlling prepayment risk is the prime concern with ABS structures of this kind, although the rate of prepayment may vary considerably by the type of asset.

Securitisation of non-amortising assets in the reference portfolio, i.e. revolving debt (such as credit card receivables, trade receivables, dealer floor-plan loans and some leases), typically sports a controlled amortisation structure with a relatively predictable repayment schedule in the bid to curb investor fears about the inherent risk of early amortisation in this kind of ABS. In controlled amortisation an ABS tranche is paid off in equal payments over a set period of time (often one or two years). Similar to corporate bonds with a sinking fund, the principal is repaid to investors over a period of less than a year after a contractually predetermined revolving period, when only defined interest payments occur (The Bond Market Association, 1998).

So-called bullet structures are a viable alternative to controlled amortisation structures for revolving assets. They are designed to return principal to investors in a single payment. Similar to controlled amortisation transactions, bullet payment structures feature two separate cash flow management periods. During the revolving period principal received from the reference portfolio is retained to buy more receivables, before the principal payments build up in an escrow account during the subsequent accumulation period to fund a future bullet payment to investors. As much as in controlled amortisation structures "bullet maturities" suffer from early amortisation risk. We distinguish between soft bullet maturity and hard bullet maturity. The former structure is the most common bullet structure, where only part of the deal is guaranteed on the...

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