What Is a Calamity Call?
A calamity call is a protective measure for investors in a collateralized mortgage obligation (CMO) that is set off assuming defaults or prepayments on the underlying mortgages take steps to interfere with the cash flow generated by the investment.
In the event that the cash flow generated by the underlying collateral isn't sufficient to pay the scheduled principal and interest payments, the issuer will retire a portion of the CMO. The measure is planned basically to reduce the issuer's reinvestment risk.
A calamity call likewise might be called a "tidy up call."
Understanding the Calamity Call
A CMO is a security that is backed by a pool of mortgages. These products are in some cases known as [Real Estate Mortgage Investment Conduits](/real-estate-mortgage-investment-course remic) (REMICs).
Banks that offer mortgages straightforwardly to home buyers sell those mortgages on to investment firms at a discount from their full value. That clears up cash for the banks to loan out once more. The organizations that buy the mortgages package them available to be purchased to investors as CMOs.
Investors buy CMOs to access the cash flow from mortgages without beginning or purchase the mortgages. CMOs earn their income as the borrowers repay their mortgages, and the repayment fills in as the collateral.
A calamity call provision reduces the risk for CMO investors, ensuring a continuous cash flow.
It is just a single type of protection utilized in CMOs. Others incorporate over-collateralization and pool insurance.
A calamity call is in some cases known as a "tidy up call."
The calamity call might be utilized in CMOs structured from second-lien mortgages, which have limited protection against default losses. For regular fixed-rate mortgages, over-collateralization might give adequate protection to the underlying pool of mortgages.
The Calamity Call in Bonds
The calamity call is additionally utilized at times in municipal bonds. In this case, it is a type of extraordinary redemption provision.
For instance, a calamity call might be utilized to offset lost revenue from a municipal bond that was issued to fund the construction of a community facility that later experiences huge damage, restricting its ability to generate revenue to repay the bond.
This sort of calamity call is in some cases known as a catastrophe call.
Illustration of a Calamity Call
Say Company An issues a $10 million CMO that generates $500,000 month to month from underlying mortgage interest and principal payments.
A huge number of mortgage holders either default on their loans or prepay them in full. The CMO no longer creates sufficient income to pay its investors.
Company A could then be required to retire part of the CMO to pay the investors.
- A calamity call provision may likewise be found in municipal bonds.
- A calamity call provision is utilized to supplant losses in CMO cash flow that can be brought about by defaults or early repayments.
- They are most frequently utilized in second-lien mortgages, which have limited protection from default risks.