medium · Asset-Backed Securities tranching
A Home Equity Loan (HEL) ABS structure uses a Shifting Interest mechanism. At closing, the Seniors (Class A) represent 90% of the deal and Subordinates (Class M/B) represent 10%.
During a 36-month lockout period, 100% of prepayments are directed to Class A. If the pool begins with 500,000,000 and experiences 20% CPR, what is the primary credit effect on Class A by Month 37?
- Class A's credit support increases because the Subordinates remain at their original dollar balance while the total pool shrinks.
- The shifting interest mechanism is disabled if any cumulative loss triggers are breached, returning the deal to pro-rata payments.
- The Weighted Average Life (WAL) of Class A will extend, providing more interest income to compensate for the shifting interest risk.
- The Class A percentage of the remaining pool will significantly decrease, as it amortizes faster than a pro-rata allocation would allow.
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