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Payments waterfall: Difference between revisions
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The theory was simple enough: if a swap counterparty has been gauche enough to default on its contractual obligation, even if forced to by the vicissitudes of [[insolvency]] — and realistically, that is the only time a regulated swap dealer of the kind that has truck with [[repackaging]]s ''will'' default on its obligations — then it should forgo its privileged place in the security waterfall, and should slum it with, or ''below'', the Noteholders. | The theory was simple enough: if a swap counterparty has been gauche enough to default on its contractual obligation, even if forced to by the vicissitudes of [[insolvency]] — and realistically, that is the only time a regulated swap dealer of the kind that has truck with [[repackaging]]s ''will'' default on its obligations — then it should forgo its privileged place in the security waterfall, and should slum it with, or ''below'', the Noteholders. | ||
At first blush this made sense, and seemed ''just'', in a “living my own truth” kind of a way, but on second | At first blush this made sense, and seemed ''just'', in a “living my own truth” kind of a way, but on second glance the analysis rather falls apart. Contractual arrangements are not meant to be punitive, judgmental or even evaluative: they are what they are, and you get what you bargained for regardless of the good or bad grace of your counterparty, as long as it is around and able to perform for you. | ||
In the case, a Noteholder bargains for “the value of the underlying asset, plus or minus the value of the [[swap]]”. This is the basic articulation of the economic value of the Note. Thus, the value of the swap is necessarily cleared to zero ''in order to determine what the Noteholder is owed''. | |||
There are two ways this can go: either the Swap Counterparty is ''[[out-of-the-money]]'' on the swap, in which case it net ''owes'' something to the Issuer and has no claim on the security package, so does not really care whether the priority is flipped or not, or it is ''[[in-the-money]]'' | |||
Given that the ratings goal — the repayment of principal at maturity — would usually be predicated on the credit rating of the swap counterparty, this made little sense. And nor did it have any real effect on the payout of the notes: if your counterparty is bust, and it is owed money, then [[Q.E.D.]], the Noteholder’s total claim is limited the the liquidated value of thee bonds minus that payment; if the counterparty owes the SPV money, then no amount of reorganising its place in the security waterfall is going to make any difference since it has no claim against the SPV in the first place. | Given that the ratings goal — the repayment of principal at maturity — would usually be predicated on the credit rating of the swap counterparty, this made little sense. And nor did it have any real effect on the payout of the notes: if your counterparty is bust, and it is owed money, then [[Q.E.D.]], the Noteholder’s total claim is limited the the liquidated value of thee bonds minus that payment; if the counterparty owes the SPV money, then no amount of reorganising its place in the security waterfall is going to make any difference since it has no claim against the SPV in the first place. | ||