What is a Clean Up Call?
A clean up call, also known as a calamity call, is a feature of a collateralized mortgage obligation (CMO) that requires the issuer to pay off a portion of the CMO if the underlying mortgages don't generate enough cash to make the principal and interest payments on the CMOs.
How Does a Clean-Up Call Work?
Let's say Company XYZ has issued $500 million of CMOs that have principal and interest payments of $2 million per month. CMOs are bonds that are backed by a pool of underlying mortgages. The interest and principal payments toward those mortgages become the interest and principal payments that go to the CMOs.
If a large number of the homeowners suddenly default on their mortgages or prepay their mortgages (by selling their houses before the mortgage is paid off), the CMO issuer might find itself unable to make those $2 million monthly payments to its holders. In this situation, a clean up call may require the CMO issuer to pay off a portion of the CMOs.
Why Do Clean Up Call Provisions Matter?
Clean up calls sound calamitous, but really they are a form of protection against default for buyers of CMOs. They also reduce the issuer's reinvestment risk.
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