PAUG

PAUG ("Pay As You Go") refers to application of credit derivatives technology to structured finance products. It works very similar to a CDS with the reference entity being a structured finance products such as ABS, CMBS, RMBS etc. The trigger events in PAUG can be classified mainly as “Credit Events” and “Floating Rate Payment Events”. PAUG is a settlement methodology for CDS on ABS reference Entities.

Credit Events in PAUG

Failure to Pay Principal – The Ref Ob fails to make scheduled principal payments.
Writedown – The Ref Ob writes down (decreases) its outstanding principal amount.
Distressed Ratings Downgrade – Distressed Ratings Downgrade is an optional credit event which is triggered when the reference obligation is downgraded to 'Caa2/CCC' or below, or the rating is withdrawn by one or more of the three rating agencies.

Floating Rate Payment Events

Interest Shortfall – The Ref Ob pays interest less than the expected interest for that period

Writedown – The Ref Ob writes down (decreases) its outstanding principal amount

Principal Shortfall – The Ref Ob fails to make schedule principal payments

Settlement Mechanism

Credit Events (Failure to pay Principal, Writedown, Distressed Downgrade) Notice of settlement can be sent by Buyer only Usually if the event is deemed to be a ‘credit event’ by the Buyer the intent is to physically settle. The Buyer of protection has the option to physically settle or cash settle- if the Buyer chooses to physically settle, the a credit event has occurred.

Floating Rate Payment Events (Failure to pay Principal, Interest Shortfall, Writedown) Notice of settlement can be sent by Calculation Agent and/or the Buyer of Protection For Failure to Pay Principal and Writedown, the difference between this being a Credit Event and a Floating Rate Payment Event is that when an event occurs the buyer chooses to cash settle and the trade continues (pay as you go). Interest shortfall is not considered a Credit Event in any instance and is always cash settle.

References

Synthetic ABS 101: PAUG and ABX

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