Pass-through transactions

In a pass-through transaction, the notes will normally be split into a number of classes that will be redeemed in order of priority. The actual speed at which the notes are redeemed will depend on the underlying repayment schedule of the mortgages in the pool and the rate at which the borrowers prepay their mortgages. (See Exhibit 11.8 for a generic example.)... 

In a pass-through transaction the issuer normally has the option to call the notes under three specified circumstances ... 

Prepayments are the most important factor in determining the redemption profile of the notes in a pass-through transaction. The prepayment rate is usually measured as an annualised Conditional Prepayment Rate (CPR), which is defined as the proportion of the outstanding balance of the mortgages that is paid down ahead of schedule during the period. Exhibit 11.10 illustrates the paydown profile for the same example transaction as in Exhibit 11.9, but with an increased prepayment rate of 35% CPR. 

Exhibit 11.11 illustrates how the credit enhancement (excluding excess spread) improves during the life of a pass-through transaction. The exhibit corresponds to the generic paydown profile shown in Exhibit 11.9, and illustrates the reduced rate of improvement in credit enhancement once the notes are paying down on a pro rata basis. 

Flexible and offset account mortgages present a significant challenge to pass-through transaction structures. This arises because the borrowers requests to redraw previous prepayments could in aggregate exceed the principal receipts. The experiences of Australian mortgage lenders. 

The combination of this redemption profile with a substitution period and/or a cash accumulation account would allow the creation of bullet securities, although at the time of writing this has not been done for a European issuer. This is not the only way to create notes that expect to have a bullet redemption profile. In the Delphinus 2002-11 transaction, the substitution period extended up to the step-and-call date, so the notes are likely to be redeemed on that date. However, if for any reason the issuer is not able or willing to call the notes, they will redeem as in a standard pass-through transaction, and so the legal maturity is dependent on the term of the underlying mortgages. 

The calculation of credit enhancement for notes in a master trust transaction seems more complicated than in a traditional pass-through transaction because subordinated notes from an earlier series are expected to be redeemed before the senior notes of later series. However, if the mortgages were to perform poorly, the trigger events ensure that all outstanding junior notes would only be repaid after all the senior notes. So the credit enhancement can be calculated as the aggregate balance of subordinate notes as a proportion of the total notes outstanding. 

The performance analysis of pass-through transactions will be similar in many respects to that described above. However, as the collateral pays down, the credit enhancement in the transaction will improve and therefore these transactions become more financially robust as they age. 

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