The relative size of the front-end senior non-NAS cash flows makes their execution highly important to the execution of the entire deal. One structuring variation used in all MBS sectors (both agency and private-label) is to split cash flows into floater/inverse floater combinations. This acts both to improve the deal execution and meet the strong and persistent demand for floating-rate assets.
Exhibit 1 demonstrates how a simple floater/inverse IO (IIO) combination can be structured from collateral or a parent tranche with a 6.0% coupon. However, there are tradeoffs associated with this technique. If the whole tranche is to be utilized, the cap of the floater equals the coupon of the collateral; this level is typically lower than that desired by investors in floating-rate bonds. If the floater cap is to be raised to a higher level, a premium/discount split must be used to create parent bonds with a high enough cap, limiting the proportion of the parent that can be structured into the floater/IIO combination.