CandleFocus

Z Tranche

The Z tranche is a type of structured financial product that carries some of the most severe risks of default and nonpayment for holders. A Z tranche is a portion of the capital structure that is only repaid after all other tranches in the structure have been paid. Instead of receiving interest payments, the Z tranche has a portion of its principal payments diverted in favor of the upper tranches, which often have higher interest payments.

The Z tranche is usually the last tranche to receive payments and as a result, holders of these tranches are most likely to experience nonpayment or default. During times of financial strain or stress, this would be especially detrimental to holders of these securities.

The Z tranche is typically used to make the more junior tranches more appealing. The idea is that if the more junior tranches receive payments, then by default, the more senior tranches will eventually receive payments. By offering a Z tranche, the issuer of the securities can add more layers of protection to the capital structure.

Due to the long duration of payments associated with the Z tranche, maturity dates are often extended to 20 years or longer from original issuance. This ensures that enough capital is available to pay off any principal and interest due on the more junior tranches.

In summary, the Z tranche is a riskier part of the capital structure for security holders. Holders are exposed to default and nonpayment risks and must wait for all other tranches to be repaid first. To make these securities attractive, the issuer can offer fully covered tranches which benefit from payments generated by the Z tranche. The maturity dates of these securities are extended to 20 years or more to ensure that enough capital is available to repay all tranches.

Glossary Index