Super-senior tranches

The static, no-loss return of the various tranches in this case might have the profile shown in Exhibit 22.6. Here the equity tranche constitutes the first 50 million of risk, and is compensated for its position in the capital structure with a very high notional spread of 20.5%, or 10.25 million per year on 50 million notional. This spread represents the annual return to the equity holder in the scenario where no losses are incurred. Conversely, the most senior tranche of risk receives only 1.05 million per year on a notional position of 700 million. The low spread return of only 15 bps ( 1.05 million/ 700 million) underscores the perceived safety of the super-senior tranche. 

On the liability side, the structure will have tranches whose allocations of income and loss are predefined. From most junior to most senior, the tranches include equity, mezzanine, senior, and super-senior. Equity, or first loss, is analogous to the equity in a company s balance sheet, and represents the residual interest remaining after other liabilities are paid off. The mezzanine, or middle tier of risk, typically represents low-rated tranches all the way up to AA risk. Senior usually refers to AA and AAA risk. Super-senior represents a level of risk that is deeply subordinated (usually by at least 10%) to AAA, and as its name implies is regarded as extremely safe. In a structure that is not uncommon, we will assume all of the liability tranches are unfunded except for the equity. ... 

The deal is structured as a senior-subordinated overcollateralization, with the first three notes all rated as AAA. These are ranked further into a super-senior and junior-senior tranche. The note tranching is the principal form of credit enhancement, in addition to the overcollateralization of 0.85 percent. There is also a reserve account to trap excess spread, which is a further credit enhancement. 

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