Waterfall Payment
Candlefocus EditorThe priority within each class is typically set by the amount of the debt, interest rate and other facts. Higher-tiered creditors are typically paid principal and interest ahead of lower-tiered creditors and the payments are waterfalled from the highest to the lowest tiers, until all creditors are paid off. Meanwhile, lower-tiered creditors, such as subordinated lenders, may only receive interest-only payments until the higher-tier creditors are paid off.
Waterfall payments structures can be used in the event of a bankruptcy, loan default or in the case of a new loan capital structure. They can even be used to pay off one loan at a time, or to allocate payment to all lenders in a systematic fashion. The amount of risk and yield each creditor is willing to take on typically sets the priority of the waterfall payment structure.
When establishing a waterfall payment structure, the creditor orders should be determined prior to contract, as this will ultimately shape the terms of the loan. Likewise, it is important to review the creditors' liens and tax implications related to the order of payments, as this may affect the project’s after-tax return and cash flow.
Waterfall payment structures are common for larger projects, such as municipal water and sewer projects, real estate development and large purchases. In essence, waterfall payment structures guarantee that higher-tiered creditors will be paid on time and in full, while also providing a system to pay lower-tiered creditors in a systematic fashion. The structure ensures profitability for the project and for the involved parties, while limiting risk and uncertainty for all creditors.