Global Securitisation and Structured Finance 2008 I Re-visiting UK mortgage master trust structures
Each trust has a different minimum seller share requirement and may in practice choose to have a seller share as high as 50 per cent, depending on the seller’s business model. A much larger seller share enables a master trust to generate sufficient cash flows to issue bullet repayment tranches in addition to controlled amortisation tranches. Bullet repayment is favoured by investors and may contribute to tighter spreads plus the additional benefit to the seller of more competitive interest rate and currency swap pricing. However, a large seller share is really economically viable only for a bank lender that has access to cheap and plentiful retail and wholesale funding sources that are used to fund the seller share.
Trust cash-flow waterfalls Master trusts have separate interest and principal cash- flow waterfalls, which direct cash flow to the multitude of tranches. The master trust structure and its safety net of triggers (see below) enable both principal to be allocated 100 per cent to the investor share and subordinate tranches to have shorter maturities and therefore to pay down prior to more senior tranches. On the other hand, in the cash-flow waterfall, revenue is always allocated according to the respective seller and investor or funding shares. At the investor level, revenue is allocated depending on the type of trust. Within a capitalist trust, the pro rata allocation for each issuing vehicle is calculated based on total outstanding note principal less PDL debit balances for each issuer, but in socialist trusts revenue flows down the waterfall in order from one class to another. In capitalist trusts individual issuing vehicle can be thought of as looking after themselves before other issuers, while in socialist trusts cash flows are shared equally in turn by rating level.
In capitalist master trusts (eg, Granite 01-1 to 04- 3), each issuing vehicle is legally separated in a way that means that an issuer will ‘selfishly’ take all it needs from its pro rata allocation of interest and principal before passing on the excess spread to other issuing vehicles, should those issuers have a shortfall, before the remainder is finally passed on to the seller. Therefore,
within each standalone issuing vehicle, principal and interest are then allocated sequentially ‘downwards’, while losses are allocated sequentially ‘upwards’ from the issuer reserve fund up to the triple-A bonds. Surplus interest (excess spread) or principal is then shared pro rata between those issuers with a shortfall.
On the other hand, socialist trusts (the bulk of master trusts including Granite de-linked from 05-1 onwards) are based on a more sharing environment where interest and principal is allocated by class (or rating level) rather than by distinct issuing vehicles, and then within each class by revenue or principal due to each tranche scheduled for payment in that specific period; only then is the excess cash flow passed on to the next lower-rated class, where it is again shared between the tranches of that class. One can think of revenue flowing through one class before flowing down to the next class and so on. This means that exposure to losses will be almost identical for a given class or rating level in a socialist trust because cash flows are not passed to subordinate classes until all tranches have received the amounts due to them. Therefore, unlike capitalist trusts, there is no requirement for excess spread to pass back round the cash flow waterfall, as all available revenue is taken on its path through the classes
Credit and structural support The two types of trust differ materially in terms of reserve funds. In capitalist trusts each standalone issuing vehicle has its own specific reserve fund and that issuer benefits if senior tranches have paid down or if pool quality has improved. On the other hand, in socialist master trusts all issuing vehicles share a single reserve fund. So, in times of weakening pool performance older issuers benefit from the fact that the reserve fund is re-assessed each time the trust is re- rated for the launch of a new issue and therefore increases in size. There are also other reserve funds in the complex world of the UK master trust. Should excess spread drop below a specified level, there may be a requirement to trap remaining excess spread into an additional reserve fund. Furthermore, should the seller
Global Securitisation and Structured Finance 2008