PAC Bond

<body onLoad="MM_checkPlugin('Shockwave Flash','','http://www.riskglossary.com/default_nofl.htm',false);return document.MM_returnValue" stylesrc="../_private/template.htm" bgcolor="#FFFFFF" link="#669933" vlink="#000000" alink="#000000"> <div align="left"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table1"> <tr> <td width="740"> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" height="37" id="table2"> <tr> <td height="35" width="100%"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" id="table3"> <tr> <td width="100%" align="left" valign="top"> <p class="header_gold">PAC Bond</td> <td width="45" align="right" valign="bottom"> <map name="FPMap6"> <area href="http://www.contingencyanalysis.com" shape="rect" coords="1, 0, 44, 11" target="_top"> </map> <img border="0" src="../images/home.gif" usemap="#FPMap6" width="45" height="12"></td> </tr> </table> </td> </tr> <tr> <td width="100%" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td width="0%" valign="top" bgcolor="#FFFFCC"> <table border="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="0" cellspacing="1" id="table4"> <tr> <td width="0%" align="left" valign="top"> <p class="header2_black">Explained:<br> <img border="0" src="../images/blank_1x100.gif" width="100" height="1"></td> <td width="100%" align="left" valign="top"><p class="word_list"> <a href="#companion">companion bond</a><p class="word_list"> <a href="#Planned amortization class">planned amortization class (PAC) bond</a><p class="word_list"> <a href="#PAC II bond">PAC II bond</a><p class="word_list"> <a href="#PAC III bonds">PAC III bond</a><p class="word_list"> <a href="#prepayment protection band">prepayment protection band</a><p class="word_list"> <a href="#subordinated PACs">subordinate PAC bond</a><p class="word_list"> <a href="#Super PACs">super PAC bond</a><p class="word_list"> <a href="#support">support bond</a><p class="word_list"> <a href="#Targeted amortization class">targeted amortization class (TAC) bond</a><br> <img border="0" src="../images/blank_1x160.gif" width="160" height="1"></td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="0" style="border-collapse: collapse" bordercolor="#111111" width="310" align="right" id="table5"> <tr> <td align="right" width="9" height="14"></td> <td width="300" height="14"> <font size="2"> </font><font size="4"> </font></td> </tr> <tr> <td align="right" width="9"> </td> <td width="300"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> </table> <p class="body"><b><a name="Planned amortization class">Planned amortization class</a></b> (PAC) bonds are a type of <a href="../articles/collateralized_mortgage_obligation.htm">CMO bond</a>. They are designed to largely eliminate <a href="../articles/mortgage_backed_security.htm">prepayment risk</a> for investors. They do this by transferring essentially all prepayment risk to other bonds in the CMO. Appropriately, those other bonds are called <b><a name="support">support</a></b> or <b> <a name="companion">companion</a></b> bonds.</p> <p class="body">PAC bonds offer a fixed <a href="../articles/par_value.htm">principal</a> redemption schedule that will be met so long as prepayments on the underlying mortgage collateral remain within a specific <a href="../articles/prepayment.htm">PSA</a> range, which is called a <b><a name="prepayment protection band">prepayment protection band</a></b>. To see how this is accomplished, suppose we have a mortgage pass-through which we want to repackage as a CMO with PAC and support bonds. We want the structure's PAC bonds to meet their principal redemption schedule so long as prepayments are between 100% PSA and 250% PSA. The question we must answer is: what principal redemption schedule can we offer and still meet this goal?</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="165" align="left" id="table6"> <tr> <td width="160"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script> </td> <td width="11"> </td> </tr> </table> <p class="body" style="margin-bottom: 36">Consider Exhibit 1. Its two graphs indicate principal payments—both scheduled payments and prepayments—from our pass-through assuming 100% and 250% PSA.</p> <div align="center"> <center> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="350" cellpadding="0" id="table7"> <tr> <td> <p class="exhibit_header"><span class="exhibit_header">Principal Payments Assuming<br> 100% PSA and 250% PSA</span><br> <span class="exhibit_subheader">Exhibit 1</span></td> </tr> <tr> <td bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td><img border="0" src="../images/ex1_pac_bond_a.gif" width="350" height="185"><br> <img border="0" src="../images/ex1_pac_bond_b.gif" width="350" height="185"></td> </tr> <tr> <td> <p class="exhibit_legend">Principal payments—both scheduled payments and prepayment—are indicated for the mortgage pass-through collateral assuming 100% and 250% PSA.</td> </tr> </table> </center> </div> <p class="body" style="margin-top: 36; margin-bottom: 36">If we superimpose the two graphs, and take the minimum of the two at each point in time, we obtain a principal redemption schedule that can be met so long as prepayments remain between 100% and 250% PSA. This is indicated in Exhibit 2.</p> <div align="center"> <center> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="350" cellpadding="0" id="table8"> <tr> <td> <p class="exhibit_header"><span class="exhibit_header">PAC Bond Redemption Schedule</span><br> <span class="exhibit_subheader">Exhibit 2</span></td> </tr> <tr> <td bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td><img border="0" src="../images/ex2_pac_bond.gif" width="350" height="185"></td> </tr> <tr> <td> <p class="exhibit_legend">A principal redemption schedule that is achievable so long as prepayments remain between 100% PSA and 250% PSA is obtained by taking, at each point in time, the minimum principal payment under either 100% PSA or 250% PSA.</td> </tr> </table> </center> </div> <p class="body" style="margin-top: 36">Once a principal redemption schedule has been determined as in Exhibit 2, it can be divided among several PAC bonds offering different maturity ranges.</p> <p class="body">PAC bonds have proven extremely popular since they were introduced in 1986. Various related structures have been devised that offer a form of subordinate prepayment protection. A <b> <a name="PAC II bond">PAC II bond</a></b> is formed from the cash flows of support bonds for regular PAC bonds. They offer a fixed principal redemption schedule so long as prepayments remain within another, more narrow, prepayment protection band. They are more risky than PAC bonds but offer higher <a href="../articles/yield.htm">yields</a>. Continuing on the theme, <b> <a name="PAC III bonds">PAC III bonds</a></b> are formed from cash flows of support bonds for PAC II bonds.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="345" align="right" id="table9"> <tr> <td align="right" width="9"> </td> <td width="336"> <script type="text/javascript"></script> <script type="text/javascript" src="http://pagead2.googlesyndication.com/pagead/show_ads.js"> </script>  </td> </tr> </table> <p class="body" style="margin-top: 20"><b><a name="Super PACs">Super PACs</a></b> and <b> <a name="subordinated PACs">subordinate PACs</a></b> are formed by dividing the cash flows of a regular PAC structure into classes offering, respectively, broader and more narrow protection bands. Super and subordinated PACs can be combined in a structure with PAC II bonds. In that structure, the PAC II bonds will be part of the support for the subordinated PAC bonds.</p> <p class="body" style="margin-top: 22; margin-bottom: 30"><b><a name="Targeted amortization class">Targeted amortization class</a></b> (TAC) bonds are analogous to PAC bonds, but are structured differently. They offer one-sided protection, shielding investors from high prepayment rates up to a specified PSA. They do not protect against low prepayment rates. TAC bonds are appealing because they offer higher yields than comparable PAC bonds. The unaddressed risk from low prepayment rates generally does not concern investors as much as risk from high prepayment rates, which the TAC structure does address.</p> <table border="0" cellpadding="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table10"> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Related Internal Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table11"> <tr> <td width="100%"> <p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/collateralized_mortgage_obligation.htm">Collateralized Mortgage Obligation</a> A type of MBS with cash flows segregated into bonds offering different maturity and risk characteristics.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/io_and_po.htm">IO and PO</a> Risky CMO bonds that pay, respectively, only the interest or only the principal from a mortgage collateral.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/mortgage_backed_security.htm">Mortgage-Backed Security</a> Securitized interest in a pool of mortgages. 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This article discusses metrics for MBS prepayment, including SMM, CPR and PSA.<p class="explanatory_text"> <img border="0" src="../images/bullet_link_glossary.gif" width="26" height="15"><a href="../articles/z_bond.htm">Z Bond</a> A type of CMO bond that accrues interest until it starts to pay down principal.</td> </tr> </table> </td> </tr> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Related Books</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table12"> <tr> <td width="100%"> <p class="explanatory_text">Fabozzi (<a target="_blank" href="http://www.riskbook.com/link/fabozzi_f_(2001).htm">2001</a>) and Hayre (<a target="_blank" href="http://www.riskbook.com/link/hayre_l_(2001).htm">2001</a>) are two excellent, comprehensive books on MBS. Both cover PAC bonds in detail.</p> <table border="0" cellpadding="4" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table13"> <tr> <td width="100" align="left" valign="top"> <map name="FPMap430"> <area target="_blank" href="http://www.riskbook.com/link/fabozzi_f_(2001).htm" shape="rect" coords="0, 0, 84, 124"> </map> <img border="0" src="../images/book_fabozzi_MBS_125.gif" usemap="#FPMap430" width="85" height="125"></td> <td align="left" valign="top"> <table border="0" cellpadding="1" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table14"> <tr> <td width="90%" colspan="3"> <p class="title"> <a target="_blank" href="http://www.riskbook.com/link/fabozzi_f_(2001).htm"> Handbook of Mortgage-Backed Securities</a></td> </tr> <tr> <td colspan="3"> <p class="author"><b>Frank Fabozzi (ed.)</b></td> </tr> <tr> <td width="10%"> <map name="FPMap431"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"></map> <img border="0" src="../images/star_6.gif" usemap="#FPMap431" width="90" height="16"></td> <td width="10%" class="author">quality</td> <td width="70%"> <p class="author"> </td> </tr> <tr> <td width="10%"><map name="FPMap432"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"> </map> <img border="0" src="../images/tech_2.gif" usemap="#FPMap432" width="90" height="16"></td> <td width="10%" class="author">technical</td> <td width="70%">  </td> </tr> <tr> <td width="10%"> <p class="author">2001</td> <td width="10%"> </td> <td width="70%"> <p align="center"><map name="FPMap433"> <area target="_blank" coords="0, 0, 145, 19" shape="rect" href="http://www.riskbook.com/link/fabozzi_f_(2001).htm"> </map> <img border="0" src="../images/pointer_review.gif" usemap="#FPMap433" width="146" height="20"></td> </tr> </table> </td> </tr> </table> <table border="0" cellpadding="4" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table15"> <tr> <td width="100" align="left" valign="top"> <map name="FPMap435"> <area target="_blank" href="http://www.riskbook.com/link/hayre_l_(2001).htm" shape="rect" coords="0, 0, 82, 124"> </map> <img border="0" src="../images/book_salomon_125.gif" usemap="#FPMap435" width="83" height="125"></td> <td align="left" valign="top"> <table border="0" cellpadding="1" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" id="table16"> <tr> <td width="90%" colspan="3"> <p class="title"> <a target="_blank" href="http://www.riskbook.com/link/hayre_l_(2001).htm"> Mortgage-Backed and Asset-Backed Securities</a></td> </tr> <tr> <td colspan="3"> <p class="author"><b>Lakhbir Hayre (Ed.)</b></td> </tr> <tr> <td width="10%"> <map name="FPMap434"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"></map> <img border="0" src="../images/star_6.gif" usemap="#FPMap434" width="90" height="16"></td> <td width="10%" class="author">quality</td> <td width="70%"> <p class="author"> </td> </tr> <tr> <td width="10%"><map name="FPMap39"> <area target="_blank" href="http://www.riskbook.com/main/ratings.htm" shape="rect" coords="0, 0, 89, 15"> </map> <img border="0" src="../images/tech_2.gif" usemap="#FPMap39" width="90" height="16"></td> <td width="10%" class="author">technical</td> <td width="70%">  </td> </tr> <tr> <td width="10%"> <p class="author">2001</td> <td width="10%"> </td> <td width="70%"> <p align="center"><map name="FPMap37"> <area target="_blank" coords="0, 0, 145, 19" shape="rect" href="http://www.riskbook.com/link/hayre_l_(2001).htm"> </map> <img border="0" src="../images/pointer_review.gif" usemap="#FPMap37" width="146" height="20"></td> </tr> </table> </td> </tr> </table> </td> </tr> </table> </td> </tr> <tr> <td height="30" valign="bottom" colspan="2"> <p class="header2_black">Sponsored Links</td> </tr> <tr> <td colspan="2" bgcolor="#CC9966" height="2"> <img border="0" src="../images/blank_2x2.gif" width="2" height="2"></td> </tr> <tr> <td bgcolor="#FFFFCC" width="75"> <img border="0" src="../images/ad_side_banner_2.jpg" width="103" height="285"></td> <td bgcolor="#FFFFCC" width="99%">  <p class="ad_legend" style="margin-left: 0; 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Anatomy of PAC bonds, <i>Journal of Fixed Income</i>, 2(1), 44-50.</td> </tr> </table> </td> </tr> <tr> <td bgcolor="#FFFFCC" colspan="2"> <table border="0" cellspacing="0" style="border-collapse: collapse" bordercolor="#111111" width="100%" cellpadding="6" id="table18"> <tr> <td width="100%" bgcolor="#FFFFFF">  <p align="center"><map name="FPMap0_I1"> <area target="_top" href="http://www.riskglossary.com" shape="rect" coords="0, 0, 164, 102"> </map><img border="0" src="../images/logo.jpg" usemap="#FPMap0_I1" width="165" height="103"></p> <p align="center"><span class="verdana10"> <a href="http://www.riskglossary.com/main/disclaimer.htm">Disclaimer</a></span></p> <p align="center">website: <span class="verdana10"> <a target="_top" href="http://www.contingencyanalysis.com">http://www.contingencyanalysis.com</a></span><br> glossary direct link: <span class="verdana10"> <a target="_top" href="http://www.riskglossary.com">http://www.riskglossary.com</a></span><br> copyright © Contingency Analysis, 1996 - current</p> <p align="center"><map name="FPMap1_I1"> <area target="_top" href="http://www.contingencyanalysis.com" shape="rect" coords="0, 0, 240, 88"> </map><img border="0" src="../images/logo_glossary_white.gif" usemap="#FPMap1_I1" width="241" height="89"></p> </td> </tr> </table> </td> </tr> </table> </td> <td>  </td> </tr> </table> </div> </body>