Overcollateralisation refers to the practice of holding more collateral than is necessary to cover the expected losses on a securitised pool of assets. Overcollateralisation is used to protect investors from losses in the event that the underlying assets default.
The amount of overcollateralisation is typically expressed as a percentage of the face value of the securitised debt. For example, a securitisation with 100% overcollateralisation would have collateral worth 100% of the face value of the debt.
Overcollateralisation can be used in a number of securitisation structures, including:
- Pass-through securitisations: In a pass-through securitisation, the investors receive the cash flows from the underlying assets directly. Overcollateralisation can be used to ensure that the investors receive their full payments even if some of the underlying assets default.
- Tranched securitisations: In a tranched securitisation, the investors are divided into different tranches, with each tranche receiving a different level of payments. Overcollateralisation can be used to protect the more senior tranches from losses.
Overcollateralisation can be a valuable tool for securitisation, but it also comes with some risks. For example, overcollateralisation can increase the cost of securitisation, and it can also make it more difficult to sell the securitised debt.
Here are some of the applications of overcollateralisation in securitisation:
- Protecting investors: Overcollateralisation can be used to protect investors from losses in the event that the underlying assets default. This is because the collateral will be used to make payments to the investors if the underlying assets do not generate enough cash flow.
- Reducing risk: Overcollateralisation can reduce the risk of a securitisation by increasing the amount of collateral that is available to make payments to investors. This can make it more attractive to investors and can reduce the cost of securitisation.
- Creating liquidity: Overcollateralisation can create liquidity in the market for securitised debt by making it more attractive to investors. This is because investors are more likely to buy securitised debt that is overcollateralised, as they are less likely to lose money if the underlying assets default.