Junior & Senior Tranches
Tranches are the AmFi system for balancing risk and return.
Last updated
Tranches are the AmFi system for balancing risk and return.
Last updated
In AmFi pools, originators typically provide capital to the junior tranche, aligning their interests with those of senior tranche investors. This alignment occurs because the originator's returns are proportional to the pool's performance, i.e., for the originator to earn a return, the pool must earn more than expected in the senior tranche.
This form of compensation is called a cascade. It is as if water is flowing: First, it fills the senior tranche with the expected returns and only what overflows from the water flows into the junior tranche. There is a yield limit for the senior tranche, but not for the junior tranche.
After the creation of each AmFi Pool and before it is opened for investment, the Originator must provide an amount of first-loss capital, referred to here as the junior tranche.
The amount typically varies between 5% and 25% of the pool's volume and is referred to here as the subordination ratio, depending on the Originator's track record in operating credit vehicles, and must be allocated to the Junior Tranche.
Investment in the Junior Tranche is not open to all investors, but only to Originators and Investors invited by them to allocate capital to this tranche.
In this way, the interests of the Originators are aligned with those of the Investors, as the Originators' own money serves as a buffer that protects the Investor from capital losses.
When capital is deposited into the Junior tranche, it is released for investment in the Senior tranche.
For example, a pool with a subordination of 10% has a ratio of 1:9, i.e. for every U$1 deposited into the junior tranche, U$9 can be deposited into the Senior tranche.
The expected Annual Percentage Yield (APY) depends on two factors:
Each operation has its own risk-return profile. A riskier operation will have a higher APY, while a less risky operation will have a lower APY;
The APY is determined based on an analysis of the originator's track record and ability to generate good operations;
Currently, institutional investors, with their extensive experience in the capital markets, handle the initial pricing of the pools. They analyze the operational structure of each pool and the guarantees with which it will operate to determine the desired yield and the minimum subordination ("tranche ratio") required.
Although key and basic information about each pool is provided (e.g., eligibility criteria, repayment period, type of assets), AmFi does not provide investment advice.
It is necessary to do your own research before investing in a pool, because as much as we are committed to bringing robust operations to our platform there are still risks involved in investing in AmFi Pools.
Each time an investor supplies the senior or junior tranche with ABRL, they receive a tranche token, which is like a "digital receipt" indicating how much they have added to the pool. Investments in AmFi Pools are made based on the tranche tokens:
When an investor allocates funds to a pool, they "buy" the pool's tranche tokens.
If the pool performs well, the value of the tokens increases.
Senior tokens accrue yield every 24 hours according to the target APY.
Junior tokens accrue yield every 24 hours according to the performance of the loans.
And when the withdrawal is available, the pool “buys back” the appreciated tranche tokens.
This dynamic of buying and selling tokens allows any investor to withdraw their investments, thus securing the profit of their investment period, and allows new investors to join the pool without compromising the previous returns.
This is how investments in AmFi pools work.
Better understanding the tranches with numbers.
