When does a tranche become worthless in a CDO?

[Martin Balaz]

I guys,

I have a question regarding CDOs.

Lets say we have a classic CDO /non-synthetic/, which holds a pool of mortgages and passes the cashflow on to the investors. What happens after the first mortgages start to default - how does it affect the payouts to various tranches?

Does it work in the way that first the principal is being paid out to all tranche holders and then, from the rest of the money interest payments are being paid in a waterfall fashion, so that the equity tranche is wiped out only after all other tranches lose interest payments? Or is so that the senior tranches get paid their principal plus interest first and only then the other tranches can get paid?

Thanks.

 

[Uncle Max]

It all depends on the structure of CDO. Usually, interest is paid first to all tranches, after that principal is paid. Senior tranche can get principal payments before interest paid to subordinate tranches to satisfy overcollaterization or interest compliance tests. You need to read prospectus to find out how exactly distribution works for a particular CDO.

 

[doug reich]

The waterfall is paid from most to least senior, so equity is always paid last. Each tranche receives interest due, and then they receive principle due (normally, as Maxrum says it can be done any way they feel like). However, equity may get paid out before other tranches are receiving principle payments because other tranches are on a schedule, and equity is the cushion.

 

[bluechimp]

Here's a simple intro to structured finance: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1287363

 

[Martin Balaz]

Thank you for replies, I will look at that paper.