First loss tranche, also equity tranche and junior tranche (first loss tranche, firstloss-piece)

In the course of a true sale securitization, a bank sells a loan portfolio to a special purpose entity established for this purpose. The latter then issues bonds in the amount of the loans taken over, thus converting the receivables into tradable securities. As a rule, these are issued in three stages. – First, in the event of default, the holders of the relatively high-interest first tranche (junior tranche, first loss pieces, FLPs) have to bear any loss; they thus assume a very high risk; to compensate for this, this tranche also bears a high interest rate compared with the other tranches. Some people also call this tranche an impact absorber or shock absorber. – The holders of the higher-interest securities of the second tranche (mezzanine tranche) are the next to be called upon to cover losses, and – the bondholders of the comparatively low-interest third part (senior tranche) of the bond are called upon to cover losses at the very end. – In principle, it is also in the interest of the lending bank to take over the first loss tranche from the special purpose entity itself. This – motivates the bank to continue to monitor the debtor and ensure that the loan is serviced and any possible collection is strictly carried out; – credibly signals to the bondholders of the mezzanine tranche and the senior tranche that everything is being done to avoid possible payment defaults (moral hazard problem!). – See back-to-originator postulate, single originator securitization, equity kicker, cash collection, hard claim, leveraged loans, originateto-distribute strategy, single master liquidity conduit, support, tacit, tranche thickness, securitization, securitization paper retention, securitization structure, waterfall principle. – Cf. BaFin Annual Report 2008, p. 55 (retention requirements).

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University Professor Dr. Gerhard Merk, Dipl.rer.pol., Dipl.rer.oec.
Professor Dr. Eckehard Krah, Dipl.rer.pol.
E-mail address: info@ekrah.com
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