ABS Questions from previous exams

Hey guys, Im reviewing some theory for ABS. I found these two questions were in previous exams with regard to ABS: 1.) Why is a “first loss protection,” an important consideration in analyzing ABS? 2.) What is the rationale for ABS securities in having a “clean up call,” provision?

  1. I understood that to be basically an administrative call for when the pool of assets has been significantly paid down, and that there is a small, uneconomic number of assets left to be serviced.
  1. Not sure about this one…where did you see this in the curriculum? My best guess is that it is referring to some type of credit tranching strcuture to absorb outright defaults before impacting the payback of the tranche you are invested. 2. The clean-up call is needed in case there has been a deterioration in the credit quality of the assets in the pool and its value falls below a certain “acceptable” level.
  1. The subordinated tranche absorbs the “first losses” up to a limit leaving the senior tranche protected. The more subordinated bonds, the better the protection for the senior tranche. 2. I agree with FastEd on the cleanup call. If the collateral of the assets falls below a certain level, the principal can be called back.