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FRM Part II · FRM Exam Part II · Structured Credit Risk

A bank analyzes a non-agency RMBS senior/subordinate structure with USD 800 million collateral: senior tranche USD 720 million, mezzanine USD 56 million, and equity/first-loss USD 24 million. Collateral losses are USD 40 million, allocated in reverse order of seniority, with no excess spread. What is the loss to the mezzanine tranche as a percentage of its principal?

The mezzanine tranche loses about 28.6%. The USD 24 million first-loss piece absorbs the first losses, leaving USD 16 million of the USD 40 million to hit the USD 56 million mezzanine tranche, and 16/56 is 28.6%. The senior tranche is unaffected.

  1. A28.6%Correct
  2. B100.0%
  3. C16.0%
  4. D71.4%

Explanation

The first-loss tranche absorbs the first USD 24 million. The remaining USD 16 million falls on the mezzanine tranche. Loss rate = 16/56 = 28.57%, about 28.6%. Allocating the whole 40 million to mezzanine would ignore the first-loss tranche, and the 71.4% figure is the surviving share of the mezzanine tranche rather than the loss.

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