What is Early Amortization?
Early amortization refers to the accelerated repayment of bond principal, generally for an asset-backed security (ABS).
How Does Early Amortization Work?
Early amortization is also referred to as payout events or early calls.
Early amortization usually occurs when the number of delinquencies on the loans underlying an ABS suddenly increases. It also can occur if the issuer's net profit after servicing fees, charge-offs, and other costs falls below an acceptable level or if the sponsor or the servicer declares bankruptcy.
When an early amortization event occurs, all principal and interest payments go to the investors regardless of the intended schedule for the return of the principal. Once early amortization occurs, it cannot be rescinded or reversed.
Why Does Early Amortization Matter?
Early amortization is a way for investors to mitigate the effects of declining credit performance or a liquidity crisis. Most rating agencies require asset-backed securities to include early amortization language as a condition of rating the debt. Though this lowers the risk associated with an asset-backed security, early amortization itself bears risk in that an investor may not earn all the interest promised over the life of the security if an early amortization event occurs.