The overcollateralization in the pool is the difference between the amount of the assets and the claims against the pool: $250,000,000 – $230,000,000 = $20,000,000.

Senior tranche investors begin to lose when the overcollateralization is gone and when the subordinated A and B tranches have defaulted, so losses must be $20,000,000 + $20,000,000 + $60,000,000 = $100,000,000 before the senior tranche suffers any losses.

Things to Remember

• Overcollateralization is a risk management technique where the value of the collateral pledged is greater than the value of the loan or investment.
• Senior tranches are the highest-rated tranches in a securitization structure and are the first to receive payments from the underlying pool of assets.
• Subordinated tranches are lower-rated tranches that absorb losses after the senior tranches have been paid.
• Tranche A and Tranche B are examples of subordinated tranches that have different levels of priority in receiving payments.
• Losses in a securitization structure are typically absorbed first by the subordinated tranches before impacting the senior tranches.