medium · Debt Capital Markets bond-instruments-structures
A 1 billion pool of residential mortgages is securitized into three tranches: Senior ($850 million), Mezzanine ($100 million), and Equity ($50 million).
If cumulative losses on the pool reach $120 million, how are the losses distributed across the tranches?
- Each tranche takes a pro-rata share of 12% of its principal.
- Senior takes $120 million because it is the largest tranche and has the most capacity.
- The waterfall stops at the Equity tranche because 'limited liability' prevents losses from moving up the stack.
- Equity takes $50 million, Mezzanine takes $70 million, and Senior takes $0.
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