A step-up margin is a feature of a securitisation that allows the interest rate on the securitised loan or security to increase at a predetermined date or dates. This is typically done to reflect the increasing risk of default as the loan ages.
For example, a securitised loan might have an interest rate of LIBOR + 100 basis points (bps) for the first five years, and then the margin would step up to LIBOR + 150 bps on the first step-up date. This would mean that investors in the securitisation would receive a higher interest rate after the first five years, reflecting the fact that the loan is more likely to default.
Step-up margins can be used to a range of applications in securitisation, including:
- To attract investors who are willing to accept higher risk in exchange for higher returns.
- To manage the interest rate risk of a securitisation.
- To align the interests of investors and borrowers.
Here are some examples of how step-up margins are used in securitisation:
- In a securitisation of home loans, the step-up margin might be used to reflect the fact that the interest rate on a home loan typically increases after the first five years.
- In a securitisation of corporate loans, the step-up margin might be used to reflect the fact that the credit risk of a company typically increases as it gets closer to maturity.
- In a securitisation of asset-backed securities, the step-up margin might be used to reflect the fact that the value of the underlying assets typically decreases over time.
A step-up margin is sometimes referred to as a "margin step-up" or a "margin increase".