hard · Asset-Backed Securities
A revolving auto-loan ABS has a sequential structure with a Class A note (initial balance $850M) and Class B note ($150M), backed by a $1,000M pool. The deal includes a cash-trapping trigger: if the 3-month average annualized net loss rate exceeds 4.0%, all excess spread is diverted from the equity holder into a spread account until it reaches a 5% target. In month 18, the pool factor is 0.62, the 3-month average net loss rate just breached 4.0%, and excess spread for the month is $2.1M. A modeler computes the cash trapped this month by applying the 5% target to the original pool balance.
Why is this approach incorrect, and what is the correct trapped amount this month (assuming the spread account starts empty)?
- It is incorrect because the 5% target should size against the current outstanding pool balance ($620M), so the account caps at $31M and this month traps the full $2.1M of excess spread up to that cap.
- It is incorrect because triggers measure losses on the original balance, so the 5% target is fixed at $50M and the modeler should instead trap only the marginal excess above the 4.0% loss threshold, roughly $1.05M.
- It is incorrect because excess spread must first cover the Class B interest shortfall before any trapping, so $0 is trapped this month and the target is irrelevant until interest is current.
- It is correct as stated because spread-account targets in auto ABS are conventionally fixed at origination as a percentage of the initial pool, making the $50M cap and the full $2.1M trap this month both appropriate.
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