Reserve accounts are accounts that are set aside to absorb losses that may occur on the underlying assets of a securitisation. In the context of securitisation, reserve accounts are typically funded with a portion of the cash flows from the underlying assets. Reserve accounts can be used to protect investors from losses in a number of ways, including:
- Paying off early defaults on the underlying assets.
- Providing for a buffer against unexpected losses.
- Increasing the credit rating of the securitisation.
There are a number of different types of reserve accounts that can be used in a securitisation transaction, including:
- Cash reserve accounts: These accounts are funded with cash.
- Credit enhancement reserve accounts: These accounts are funded with credit enhancements, such as letters of credit or insurance.
- Overcollateralisation reserve accounts: These accounts are funded with overcollateralisation, which is excess cash flows from the underlying assets.
The amount of money that is held in a reserve account will vary depending on the type of securitisation and the level of risk that the investors are willing to accept.
Here are some applications of reserve accounts in securitisation:
- Mortgage-backed securities: In a mortgage-backed security, the reserve account is typically funded with a portion of the monthly mortgage payments. The reserve account can be used to pay off early defaults on the mortgages or to provide for a buffer against unexpected losses.
- Collateralized debt obligations: In a collateralized debt obligation, the reserve account is typically funded with a portion of the interest payments from the underlying debt securities. The reserve account can be used to pay off early defaults on the debt securities or to provide for a buffer against unexpected losses.
Reserve accounts are an important part of the securitisation process. They help to protect investors from losses and ensure that the securitisation can continue to function effectively.