Targeted Amortization Class (TAC): Definition, Structure, and Practical Application

Targeted amortization class (TAC) is a specialized type of asset-backed security designed to protect investors from prepayment risk. TAC tranches adhere to a predetermined principal balance schedule established using a single prepayment speed assumption (PSA). Unlike planned amortization class (PAC) tranches, which incorporate a range of prepayment rates, TAC tranches rely solely on one PSA.

TAC tranches enhance cash flow predictability within asset-backed securities, particularly collateralized mortgage obligations (CMO) and mortgage-backed securities (MBS). As a form of bond within these structures, TAC tranches follow a predetermined principal payment schedule. Any prepayments are amortized to maintain this schedule, ensuring consistent cash flow even amidst changing prepayment rates and interest rate environments.

While PAC tranches incorporate a range of prepayment rates into their structure, TAC tranches rely on a single prepayment speed assumption. Consequently, TAC investors may receive more or less principal than scheduled based on actual prepayment rates. In scenarios where prepayment rates fall below the defined rate, TAC tranches may require an extension to fulfill scheduled payments. Conversely, if prepayment rates exceed the PSA used for TAC, investors may face returns in a less favorable interest rate environment.

TAC tranches protect investors from prepayment risk by adhering to a specific principal payment schedule based on a single prepayment speed assumption (PSA). This structure ensures a predictable cash flow even amidst changing prepayment rates.

TAC tranches are commonly linked with collateralized mortgage obligations (CMO) and mortgage-backed securities (MBS), where they serve as a bond-like component.

Unlike PAC tranches, which utilize a range of prepayment rates, TAC tranches rely on a single prepayment speed assumption. This difference affects the predictability of principal payments based on actual prepayment rates.

PAC tranches are senior to TAC tranches, yielding lower but safer returns. This hierarchical structure affects the risk and return profiles of TAC tranches within asset-backed securities.