Securitization has recently taken hold of the prime banks in the U.K., as it increasingly becomes a commoditized product. A clear manifestation of that is the more frequent application of the master trust structure.

The master trust structure has traditionally been associated with U.S. credit cards securitization, and gradually extended to include other countries and asset types - corporate loans in the CLO area, aircraft leases in large aircraft securitizations, and most recently mortgages. Certain modifications are made to the master trust in order to accommodate and reflect the specific features of the respective asset type and/or jurisdiction.

It is common knowledge that the use of the master trust structure allows banks to establish a vehicle for multiple issuance and quickly access the market under most favorable conditions. It also allows issuers to use a single large pool of assets to back bonds and notes with different characteristics targeted at different investors.

Differences in Master Trust Structures - Excess Spread

What is less widely known is the existence of different types of master trust structures, the main differentiating features being the allocation of the cash flows among the numerous series of notes outstanding, and especially:

* The allocation of excess spread (servicing) from some series who face excess to other series who face shortfalls in the required cash flows; the application of excess spread to make principal payments, etc.

When analysing notes issued by a master trust, investors should familiarize themselves with the above differences. A key question should certainly be: how does the performance of the other series in the trust affect the performance of a given series held by the investors? The different series in a trust are exposed to the same level of yield and same level of losses and servicing fee expenses, but to different levels of coupon payments, i.e. interest expenses and other expenses (swaps, etc.); as a result the servicing shortfall/excess may differ among series.

So, how are these shortfalls/excesses applied and reallocated among the series? In some cases, the shortfalls (when they are very large) may be shared by all series, in other cases they may be limited to the respective series facing a shortfall. Yet in other cases, excess spread from one series may be re-directed to series facing shortfalls.

In addition, the series may have certain specific excess spread capture mechanisms, which require accumulation of excess spreads in a designated reserve account for the benefit of that series or its most junior tranche under certain circumstances. Consequently, the excess spread from that series available to other series in the master trust would be reduced. In most cases of master trust structures any residual excess spread is released to the originator. One exception is the aircraft master trust structure, where the excess spread is used to turbo' the principal repayment of the senior bonds outstanding:

* the allocation of principal from non-amortizing to amortizing series, or from non-accumulating to accumulating series.

Differences in Master Trust Structures - Principal

Another key point in a master trust structure is the allocation of principal to repay the series, or the type of amortization. The principal can be:

1. Accumulated in a special account to ensure a bullet payment at expected maturity of the notes (the so-called accumulation structure meant to establish a soft bullet), for example, the CARDS master trust, or

2. passedthrough up to a specified amount (controlled or regulated amortization structure), for example, Arran One, or fully (rapid amortization structure, usually a result of the occurrence of a trigger event).

In this regard, it is the level of principal payment rate that determines the speed of accumulation of the principal to achieve the soft bullet structure or the speed of amortization in case of rapid amortization. In case of controlled amortization the required principal payment rate necessary to meet the required controlled principal payment amount is usually much lower than the actual pool principal payment rate.

Another aspect of the allocation of principal collections is related to the revolving period. In a typical credit card master trust structure the revolving period is followed by an amortization or an accumulation period. In a mortgage master trust structure the revolving period may be interrupted in order to accumulate collected principal and prepayments, and resume upon payment of the soft bullet.

Additional questions that arise when analysing a mortgage master trust concern the effects of slow-down or increase in prepayments on the amortization (or accumulation) of the respective classes and/or series. For example, in a mortgage pool the collected principal and prepayments are used to repay principal to the bondholders. If, for example, the prepayment rate considerably slows down during the accumulation period, a soft bullet bond may face increased extension risk.

An interesting structural development (introduced in the mortgage master trust, Mound Finance, and likely to be replicated in future mortgage master trusts) is the ability to use collected principal and prepayments allocated to both the seller and the investor piece in order to ensure the soft bullet payment on expected maturity date. This partially explains the larger size of the seller piece of minimum 15%. In a typical credit card master trust structure, the seller piece is usually about 5% to 7% and such re-distribution of principal allocated to the seller piece is not allowed.

This article is an extract from Merrill Lynch's International ABS/MBS Monitor of 14 July, 2000.

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