otherwise payable to the residual class residual cash flows primarily due to the impacts of prepayments, credit losses and delinquencies. Faster prepayment rates amortize the principal balance of the loan collateral more rapidly and directly reduce the excess interest portion of residual cash flows in the same manner that faster prepayments reduce IO cash flows.

Credit losses resulting from the defaults and foreclosures experienced by the loan collateral have both a direct and indirect effect on the amount of monthly cash flows payable to the residual class over time. Residual payments are directly affected by credit losses in that they are lowered by the amount of credit losses sustained each month. Residual cash flows are reduced first in order to protect the more senior MBS issued against reductions in cash flow resulting from credit losses sustained by the underlying mortgage loan collateral. Residuals are commonly referred to as subordinated MBS, as a result.

Credit losses indirectly affect the timing and amounts of residual payments through their impact on over collateralization requirements. Typically, private label MBS transactions are structured so that excessive credit losses trigger a redirection of excess cash flow away from the residual class and toward reducing the principal balance of the senior class securities in order to increase their over collateralization and credit support. This redirection of cash flow delays or reduces payments to the residual holder representing the repayment of over collateralization. High amounts of seriously delinquent loans can delay payments similarly by triggering the redirection of cash flow away from the residual class. Reductions in the amounts of cash flow payable to the residual class over time, resulting from delinquency and loss trigger events, are possible because excess cash flow maintained as over collateralization remains subject to reductions if future credit losses are excessive.

The terms and conditions under which excess cash flows are distributable to the residual class are typically detailed in the MBS offering documents under sections that discuss the debt service requirements of the senior bonds. It is critical that the factors governing the amounts and timing of residual cash flows, over collateralization requirements, delinquency and loss triggers specified in these documents be understood if the timing and amounts of cash flows to the residual are to be accurately modeled.

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