secondarymortgage.comNon-Agency structuring realities
Non-Agency deals rely on internal/external credit enhancements and strict payment waterfalls to achieve target ratings and investor protections.
Credit enhancement in non-agency deals comes from overcollateralization, excess spread, and subordination—each creating a buffer against early loss. A typical deal requires minimum overcollateralization of 5% to 10% of initial principal balance, plus retention of a residual interest by the sponsor. These thresholds are set in the offering circular and must be met at closing and periodically thereafter.
Waterfall mechanics prioritize interest over principal and senior tranches over junior ones. Principal losses hit the most junior tranche first, with subsequent tranches absorbing losses only after earlier layers are fully impaired. Excess spread after servicing, fees, and interest payments is used to rebuild OC or pay down principal—depending on the trigger status (early or late amortization).
Letters of credit provide external credit support, often issued by banks for the benefit of bondholders. They typically cover specific shortfalls in interest or principal payments and activate after internal enhancements are exhausted. The LC size and draw conditions are defined in the indenture and require ongoing issuer compliance with covenants, including maintenance of minimum liquidity or collateral coverage ratios.
