What Is a Falling Down Waterfall
A falling down waterfall is a cash flow distribution method used in structured finance where payments are redirected downward to lower tranches when scheduled payments are missed or insufficient. It is a common feature in asset-backed securities and collateralized loan obligations.
How a Falling Down Waterfall Works
Under normal conditions, cash flows are allocated to senior tranches first. When a borrower defaults or a scheduled payment is not made, the waterfall can fall down, diverting available cash to subordinate tranches that are next in line. This process continues until all eligible tranches receive their pro rata share or the cash is exhausted.
Why Falling Down Waterfalls Matter
Falling down waterfalls define risk and recovery priorities for investors. They clarify which tranches absorb losses first and how recoveries are distributed. Investors use these structures to assess credit risk, expected returns, and the likelihood of losses in complex securitization transactions.
For a general overview of waterfall structures in finance, see the Investopedia article on Waterfall Analysis: Waterfall Analysis.
