What is a PAC tranche and how does the 'collar' protect its schedule?

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AcadiFi · Accepted Answer

A Planned Amortization Class (PAC) is a CMO tranche designed to pay principal on a pre-set schedule as long as actual prepayment speeds stay inside a collar, typically 100-250 PSA. Companion (support) tranches absorb deviations. How it works: at issuance, structurers compute the principal schedule that the PAC can deliver at both the low speed (100 PSA) and the high speed (250 PSA). The tranche receives the minimum of those two schedules each month. If actual speeds fall within the collar, the PAC pays exactly on schedule and has near-bullet average life. Any excess or shortfall flows to the support class. Example: Bromley PAC I has a 100-250 PSA collar and a 7.0-year projected WAL. If the pool prepays at 180 PSA, the support tranche is burned through faster but the PAC sticks to its schedule. If speeds hit 320 PSA, the PAC eventually 'breaks' its upper band and begins receiving faster principal — the point at which the support is exhausted. ```mermaid flowchart LR C[Pool cash flow] --> PAC[PAC band
100-250 PSA] C --> S[Support tranche
absorbs shocks] S -.->|exhausted| PAC ``` PACs trade at tighter OAS (lower yield) than sequentials because their convexity is much closer to a Treasury. The price is that support tranches are extremely volatile and demand a large OAS premium.

What is a PAC tranche and how does the 'collar' protect its schedule?

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