A waterfall is a mechanism that determines how the cash flows from the underlying assets are distributed to the investors in a securitisation. A waterfall is sometimes referred to as a "cash flow waterfall".
The waterfall is typically set out in the securitisation documents and it will specify how the cash flows are to be distributed to the different tranches of investors. The tranches are ranked in order of seniority, with the most senior tranche receiving the first priority of payment. If there are any defaults on the underlying assets, the losses will be allocated to the tranches in reverse order of seniority, with the most junior tranche bearing the most losses.
The waterfall is a valuable tool for securitisation because it provides investors with a clear understanding of how their investment will be repaid. It also helps to ensure that the most senior tranches of investors are protected in the event of defaults on the underlying assets.
Here are some of the applications of waterfalls in securitisation:
- To provide investors with a clear understanding of how their investment will be repaid: The waterfall provides investors with a clear understanding of how their investment will be repaid. This is important for investors because it allows them to assess the risk of their investment and to make informed investment decisions.
- To ensure that the most senior tranches of investors are protected in the event of defaults on the underlying assets: The waterfall ensures that the most senior tranches of investors are protected in the event of defaults on the underlying assets. This is important for investors because it provides them with a level of security that they would not have if there was no waterfall in place.
- To manage the risk of the securitisation: The waterfall can be used to manage the risk of the securitisation. For example, the waterfall can be structured to ensure that the most senior tranches of investors are repaid first in the event of defaults on the underlying assets. This will help to protect the most senior tranches of investors and to reduce the risk of the securitisation.
Waterfalls are a valuable tool for securitisation. They provide investors with a clear understanding of how their investment will be repaid, they ensure that the most senior tranches of investors are protected in the event of defaults on the underlying assets, and they can be used to manage the risk of the securitisation.