Financial Excess Interest
Excess interest represents the difference between the collateral weighted average mortgage rates and the weighted average cost of the liabilities, net of fees and expenses. Generally, the mortgage loans are expected to generate more interest than required to pay the liabilities.
To the extent that excess interest (net of fees, expenses or derivative payments) is positive, it is used to absorb losses on the mortgage loans. After the financial obligations of the trust are covered, excess interest is used to maintain overcollateralization at the target level.
Several factors could affect the extent to which excess interest is available to maintain overcollateralization:
Full or partial repayments and defaults may reduce the amount of excess interest. This is because borrowers with mortgage loans carrying higher WACs have a greater tendency to repay. This, in turn, reduces the weighted average rate of the underlying mortgage loan pool (this is commonly referred to as WAC drift).
If the rates of delinquencies, defaults or losses turn out to be higher than expected, excess interest will be reduced by the amount necessary to compensate for any shortfalls in the cash available to make required distributions to the senior and mezzanine certificates.