How does a TAC (Targeted Amortization Class) tranche differ from a PAC tranche?

A Targeted Amortization Class (TAC) tranche provides prepayment protection on one side only — typically protecting against faster-than-expected prepayments but NOT against slower-than-expected prepayments (extension risk). This contrasts with PAC tranches that protect on both sides.

PAC vs. TAC Protection:

How TAC Works:

A TAC is designed to receive a fixed principal schedule at a single prepayment speed (the "target"), say 150 PSA.

• At 150 PSA: TAC receives exactly its scheduled payment
• Above 150 PSA (fast prepayments): Excess prepayments are redirected to the support tranche, protecting the TAC's schedule
• Below 150 PSA (slow prepayments): TAC extends because there is no mechanism to accelerate payments from the support tranche to the TAC

Example — Millbridge CMO Trust:

Notice: The TAC's WAL is stable at or above the target speed but extends significantly below it. The PAC maintains 7.0 years across all scenarios within its band.

Why Choose a TAC?

1. Higher yield: TAC offers 15-30 bps more yield than an equivalent PAC because it accepts extension risk
2. Contraction protection is sufficient: If an investor's primary concern is early repayment (contraction) rather than extension, TAC provides adequate protection at a lower cost
3. Falling rate environment: When rates are declining and prepayments are accelerating, TAC tranches perform well because their upper-side protection is active

When TAC Is Dangerous:

In a rising rate environment, prepayments slow dramatically. The TAC extends far beyond its expected life, and the investor is locked into a below-market coupon for much longer than anticipated.

CFA Exam Tip: Remember TAC = one-sided (contraction protection only). PAC = two-sided (contraction AND extension protection). This distinction is a common exam question.

For more CMO analysis, check our CFA fixed income course.