Pass Through Certificates (PTCs)
The cash flows from the underlying collateral are passed through to the holders of the securities in the form of monthly payment of interest, principal and prepayments. In other words, the cash flows are distributed on a pro-rata basis to the holders of the securities. The payments occur, when the holder of the underlying asset prepays the remaining principal before the final scheduled payment month. Any prepayment is also proportionately passed on to the security-holders leading to the quicker retirement of their underlying principal. Critical to pricing of pass through are the specific features of that particular collateral. All the securities are terminated simultaneously as the list payment on the pool leads to its complete amortisation. Some of the main features of PTCs are:
– They reflect ownership rights in the, assets backing the securities.
– Prepayment precisely reflects the payment on the underlying mortgage. If it is a home loan with monthly payments the payments on securities would also be monthly but at a slightly less coupon rate than the loan.
– As underlying mortgage is self-amortising. Thus, by whatever amount it is amortised, it is passed on to the security-holders with prepayment.
– Prepayment occurs when a debtor makes a payment which exceeds the minimum scheduled amount. It shortens the life of the instrument and skews the cash flows towards the earlier years.