Payment priority

All securitization structures incorporate a cash waterfall process, whereby all the cash that is generated by the asset pool is paid in order of payment priority. Only when senior obligations have been met can more junior obligations be paid. An independent third-party agent is usually employed to run tests on the vehicle to confirm that there is sufficient cash available to pay all obligations. If a test is failed, then the vehicle will start to pay off the notes, starting from the senior notes. The waterfall process is illustrated in FIGURE 15.2. 

As tariffs in the secondary market are market clearing, the owners also collect the full scarcity payments. Hence, the investment incentives should be better than under a marginal cost-pricing regime. The owners rights are pursued, as they are given priority when capacity is scarce, nor are they being inadequately compensated by low tariffs. 

Improving access, fostering appropriate use, and reducing unnecessary expenditures continues to be a challenge for the poor, the uninsured, minority groups, rural and inner city residents, and other priority populations. The agency supports studies of access, healthcare utilization, and expenditures to identify whether particular approaches to healthcare delivery and payment alter behaviors in ways that promote access and/or economize on healthcare resource use. 

Like ABS, the cash flows realised on the underlying assets are the primary source of funds nsed to extingnish the CDO s liabilities. These realised collections are applied to each class of notes pursuant to a priority of payments that is commensnrate with the rating seniority. Pnrsnant to this payment waterfall, the most senior payment obligation mnst be satisfied in full before the next payment can be addressed, this continnes sequentially nntil the most jnnior liability is discharged. For the avoidance of doubt, if there are insufficient funds available, the payment obligations of the most jnnior liabilities will be suspended and payable in the future to the extent snbseqnent collections become available. 

The waterfall process for interest payments is shown at Exhibit 15.7. Before paying the next priority of the waterfall, the vehicle must pass a number of compliance tests designed to measure the overall robustness of cash flow being generated by the collateral portfolio. These metrics include tests such as interest coverage and principal (par) coverage, which is similar in concept to bank loan covenants and explained more fully later. 

These tests are calculated on a regular basis as well as each time the composition of the portfolio is altered, that is, each time assets are sold, purchased, or paid off ahead of their legal maturity date. If the test results fall below the required minimum, trading activity is restricted to only those trades that will improve the test results. Certain other compliance tests are viewed as more critical in terms of maintaining note repayment integrity therefore, if any of them are failed, the cash flows will be diverted from the normal priority of payments and begin sequentially paying off the notes based on seniority until the test results improve. These include ... 

From the Lender s perspective, the Lender will, at the time of negotiating the Liquidity Facility, wish to keep control on whether or not to extend the Liquidity Facility beyond the first anniversary of the issue of the Class C-1 Exchangeable Notes. In the Priority of Payments, the Lender will usually wish to be senior, or at least rank pari passu, with the most senior noteholders, in this case, the Class A Exchangeable Notes holder. 

The drafting of the Priority of Payments is probably the clause that will take the most time for the documentation of the Exchangeable Notes. In addition to the Priority of Payments clause determining what would occur if the Final Notes are not issued and the collateral needs to be realised, two additional waterfalls will be necessary, one to determine what to do with the interest paid in the Collateral Debt Securities during the Warehouse Stage on the Final Closing Date, the second to determine what to do with the proceeds from the issuance of the Final Notes (see below). 

The Trustee will create security over the assets of the issuer (including, without limitation, the Collateral Debt Securities, Eligible Investments and cash accounts). Such security will be by way of first fixed charge and will be for the benefit of all the secured parties including the Noteholders. If there is an event of default under the Notes, the security will become enforceable and the Trustee will be involved in liquidating the assets in order to meet the claims of the various creditors in accordance with a predetermined order of priority of payments. The Trustee is also responsible for acting on behalf of the Noteholders in order to make sure any amendments to any documents and the like are not prejudicial to the Noteholders. 

Generally, the trustee takes first priority in the post enforcement priority of payments scheme (i.e., the order by which monies in the structure are distributed to the bondholders and other secured creditors). However, the trustee cannot necessarily expect a transaction in default to produce sufficient cash flows to cover the fees, expenses and potential legal liabilities it might incur in dealing with a default scenario. Accordingly, most trustees will be reluctant to take action upon an event of default situation without the explicit mandate of the bondholders. The trustee will not only be looking to the bondholders for indemnification, but also for assurance that the requisite number of bondholders (normally a majority) agrees that acceleration of debt/enforcement of the security is prudent under the circumstances. 

The prepayment rate lies below the band. The upper limit will drift upward, because more companion bonds are available to receive a greater level of prepayments in the future the lower band may also rise by a small amount. This type of drift is relatively rare, however, since PACs have the highest priority of all classes in a CMO stmcture until the payment schedule is back on track. 

Subordination. Each tranches rights to and priority in receiving interest and principal payments are set out in an issues offering circular, which provides a detailed description of the notes and their legal structure. In allocating cash flows, typically, fees and expenses are subtracted from the cash flows, then the most senior tranches are serviced, followed by the junior tranches, and finally the equity tranche. This method of cash flow is sometimes referred to as a cash flow waterfall. 

Input based methods tempt the providers in increasing the number of inputs so as to earn higher revenues. An output based method, on the other hand, creates incentives to increase the number of services. Input-based payments, unlike case-based payments, do not foster competition because the money does not follow the patient. Resource allocation is not responsive to changes in demand and utilization, and is often determined by historical patterns and political priorities. 

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