What is the purpose of the step-down provisions in a securitization?

What will be an ideal response?

Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming them into a security. An important feature in analyzing senior-subordinated bond classes or deals backed by residential mortgages is the deal's step-down provisions in a securitization. The purpose of these provisions is to allow for the reduction in credit support over time. A concern that investors in the senior bond class have is that if the collateral performance is deteriorating, step-down provisions should be altered.

The provisions that prevent the credit support from stepping down are called "triggers." Principal payments from the subordinated bond classes are diverted to the senior bond class if a trigger is reached. There are two triggers based on the level of credit performance required to be passed before the credit support can be reduced: a delinquency trigger and a loss trigger. The triggers are expressed in the form of a test that is applied in each period. In addition to triggers based on the performance of the collateral, there is a balance test. This test involves comparing the change in the senior interest from the closing of the deal to the current month.