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One of the keys to understanding how net interest margin securities, or NIMs, are structured is to understand how the "triggers" from the underlying asset-backed transaction work. The purpose of this article is to explain those triggers and their impact on the residual cash flows to a NIM. We start by defining what NIMs, residual cash flows, and triggers are.
A NIM securitization structure is created when an issuer securitizes residual cash flows from one or more existing asset-backed transactions. Those transactions are most often securitized home equity loans but also may be securitized manufactured housing loans, home improvement loans, and subprime mortgages. Residual certificates receive cash flow only after all fees and expenses related to the underlying transaction and amounts due on all other classes of certificates have been paid, based on certain requirements for credit support. Credit support from an underlying transaction can come from overcollateralization, excess spread, subordination (internal credit enhancement), or a derivative, guarantee, or insurance policy (external credit enhancement). Overcollateralization is the difference between the principal balance on the underlying collateral and the bond balance. Overcollateralization is achieved through either excess collateral or excess spread. Excess spread is created when the interest rates for underlying collateral minus fees and expenses are more than sufficient to pay holders of the securitized debt. If overcollateralization is funded up front on day one and excess spread continues to accumulate, then excess spread will be distributed to owners of the deal's residual cash flows, the equity owners in the deal, or bonds in the deal that are structured to receive those residual cash flows. Those bonds are called NIM securities. The provisions that allow for a reduction of credit support over time and distribution of cash to equity and NIM security holders are known as triggers.
In the financial world in general, a trigger is defined as an event, such as a change in a price, rate, or credit rating, that in turn causes or requires a specific action. With securitized home equity loans, for example, triggers are structured to balance cash flows, to provide or maintain adequate reserve levels, and to establish thresholds for delinquencies and losses.
IMPACT OF TRIGGERS
Triggers have an impact on the reallocation of cash flows in a...