Case 088Structured finance and securitisationWarm up
A securitisation trust collects Rs 90 crore this quarter and owes senior interest and principal, then junior interest and principal, in that order. Run the waterfall and show who is short.
1The situation
Pravalis Receivables Trust holds a pool of vehicle loans bought from a finance company and has issued two classes of notes. This quarter the pool collects Rs 90 crore of interest and principal from borrowers.
The payment order in the trust deed is: senior interest of Rs 8 crore, then senior scheduled principal of Rs 60 crore, then junior interest of Rs 5 crore, then junior scheduled principal of Rs 25 crore. Unpaid junior principal carries forward to the next quarter. Ignore trustee and servicer fees.
2Your task
Run the waterfall. Who is paid in full, who is short and by how much, and how far could collections fall before the seniors miss anything?
Quick check
Who is short this quarter, and by how much?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
The seniors are paid in full, junior interest is paid in full, and junior principal is Rs 8 crore short. Rs 90 crore pays 8 and 60 to the seniors, 5 of junior interest, and leaves Rs 17 crore against Rs 25 crore of junior principal. The shortfall carries forward. Collections could fall to Rs 68 crore, 24.4% below this quarter, before the seniors miss a rupee: the order of payment is their protection.
Step 1What does a waterfall actually do?
It decides who is paid first when there is not enough for everyone. Picture a stack of glasses in a tower: pour from the top and the top glass fills before any water reaches the next. A cash waterfallThe fixed order in which a securitisation pays its investors and costs out of collections, each step paid in full before the next. pays each claim in full, in order, and the last claim in line takes the whole shortfall. That is why the same pool can back a senior note and a junior note with very different risk.
Step 2How does this quarter's Rs 90 crore run?
Step by step. Senior interest takes Rs 8 crore, leaving Rs 82 crore. Senior principal takes Rs 60 crore, leaving Rs 22 crore. Junior interest takes Rs 5 crore, leaving Rs 17 crore. Junior principal is owed Rs 25 crore and gets the last Rs 17 crore, Rs 8 crore short, which carries forward to next quarter. The total owed was Rs 98 crore against Rs 90 crore collected; the Rs 8 crore gap lands entirely on the last step.
Step 3How much protection does the order give the seniors?
Ask how far collections could fall before the seniors are touched. Seniors need Rs 68 crore a quarter, so collections could fall from Rs 90 crore to Rs 68 crore, 24.4%, before a senior rupee is missed. That cushion is the junior class, which is why a rating agency's first question on a senior note is how thick the layer beneath it is and how fast collections could fall in a bad year.
| Collections, Rs crore | Seniors paid | Junior interest | Junior principal | Who is short |
|---|---|---|---|---|
| 98 | 68 | 5 | 25 | Nobody |
| 90, this quarter | 68 | 5 | 17 | Juniors, 8 |
| 73 | 68 | 5 | 0 | Juniors, 25 |
| 68 | 68 | 0 | 0 | Juniors, 30 |
| 60 | 60 | 0 | 0 | Seniors 8, juniors 30 |
Close with what an analyst watches next. A shortfall in one quarter is not a default on the junior notes if the deed lets principal carry forward, but it is an early warning. The questions are whether collections are falling because borrowers are paying late or not at all, and whether the deed has triggers that divert cash to the seniors once losses pass a threshold.
Where candidates lose it
The common slip is sharing the shortfall pro rata across both classes, as if the trust were a single loan. The entire design of a securitisation is that the order of payment, not the size of the claim, decides who bears the loss.
The second is calling the Rs 8 crore a default. Under this deed junior principal carries forward; the right word is a shortfall, and the question is whether it is recovered.
What the interviewer asks next
- The deed has a trigger: if any junior principal is unpaid, all cash after senior interest goes to senior principal. Rerun the quarter.
- How would a cash reserve of Rs 10 crore change who is short?
- Why does the junior tranche earn a higher coupon, and how much higher would you want?
Company names and figures are illustrative.