Tranche Structuring - Loss Apportionment & Recovery of Funds

Recall in the Loan Tranches Explained Section that the Senior Tranche offers the lowest APY and carries the lowest risk, as it has the highest priority ranking position among Kasu Lenders in the capital structure to claim recoveries (if available). The Mezzanine Tranche offers a higher APY due to its second ranking position, with the Junior Tranche offering the highest APY due to its lowest ranking priority.

Unrealised Losses Vs Realised Losses

The accounting mechanism for losses on Kasu is based on the concept of Unrealised Losses and Realised Losses. This allows Kasu to apportion losses and recoveries in an orderly manner across the capital structure and the associated Tranches.

For example, if an End Borrower is in default of their loan obligation to the point where the Delegate expects there to be a loss, but the loss is yet to materialise, an Unrealised Loss is recorded by the Delegate. The Delegate will subsequently enforce a formal recovery action, which may include exercising its security position. Any funds that aren't recovered during this process are then recorded as a Realised Loss.

In the context of how this affects Kasu Lenders via the Tranching structure, the following summary is provided:

Senior Tranche

• The Senior Tranche is the highest-ranking Tranche in the capital structure. It therefore offers the lowers interest rate (APY) than all other Tranches as it generally carries the lowest risk.

• In the event of End Borrower default where the Delegate has deemed there to be expected losses (Unrealised Losses that are yet to be realised), the Delegate will enforce formal recovery action upon the End Borrower(s) in default. In such a case, Senior Tranche Lenders will have the first claim on any recovered funds.

• Any funds that aren’t recovered (and therefore result in Realised Losses) will be absorbed by Junior Tranche Lenders first, followed by Mezzanine Tranche Lenders, prior to being absorbed by Senior Tranche Lenders last (if not already fully absorbed by Junior and Mezzanine Tranche Lenders first).

• Due to its highest ranking priority in the capital structure, the Senior Tranche is of lower risk than the Mezzanine and Junior Tranches, and therefore offers the lowest interest rate (APY).

Mezzanine Tranche

• The Mezzanine Tranche is positioned between the Senior and Junior Tranches. It generally offers a higher interest rate (APY) than the Senior Tranche, but carries increased risk.

• Mezzanine Tranche Lenders are subordinated to Senior Tranche Lenders. This means that in the event of End Borrower default where the Delegate has deemed there to be expected losses (Unrealised Losses that are yet to be realised), the Delegate will enforce formal recovery action upon the End Borrower(s) in default. In such a case, Mezzanine Tranche Lenders are able to recover funds only after all Senior Tranche obligations have been fulfilled first. This only assumes enough funds have even been recovered (by the Delegate after enforcing formal recovery action upon the End Borrower(s) in default) to benefit Mezzanine Tranche Lenders. Otherwise, Mezzanine Tranche Lenders will incur Realised Losses.

• Any funds that aren’t recovered (and therefore result in Realised Losses) will be absorbed by Junior Tranche Lenders first, followed by Mezzanine Tranche Lenders (if not already fully absorbed by Junior Tranche Lenders first).

Junior Tranche

• The Junior Tranche is the lowest ranking Tranche. It generally offers the highest interest rate (APY) but also bears the greatest risk.

• Junior Tranche Lenders bear the lowest ranking priority in the capital structure. This means that in the event of End Borrower default where the Delegate has deemed there to be expected losses (Unrealised Losses that are yet to be realised), the Delegate will enforce formal recovery action upon the End Borrower(s) in default. Junior Tranche Lenders can participate in recoveries only after all Senior and Mezzanine Tranches obligations have been fulfilled first. This only assumes enough funds have even been recovered (by the Delegate after enforcing formal recovery action upon the End Borrower(s) in default) to benefit Junior Tranche Lenders. Otherwise, Junior Tranche Lenders will incur Realised Losses.

• Any funds that aren’t recovered (and therefore result in Realised Losses) will therefore be absorbed by Junior Tranche Lenders first.

Unlike the debt hierarchy (ranking priority) methodology associated with Tranching in TradFi (commonly referred to as a waterfall payment structure which also applies a ranking priority to general repayments of principal and interest), Loan Tranches on Kasu only apply a ranking priority in the case of losses and recoveries (not principal repayments and interest repayments). I.e. all loan Tranches on Kasu have equal ranking to principal repayments and interest earnings (assuming no losses or defaults). Similarly, all loan Tranches on Kasu also have equal ranking to Withdrawal Requests (subject to Loyalty Levels and queuing and assuming no losses or defaults).

In conclusion, Tranches absorb losses in the following order: Junior, followed by Mezzanine, and finally Senior. The reverse is true for recoveries. This structure provides a ranking priority in the event of losses and recoveries. By lending in a particular Tranche, Lenders therefore face inherent risks associated with their chosen position in the capital structure. It is crucial for Lenders to thoroughly assess their risk tolerance, lending objectives, and financial situation before committing capital to any Tranche within a Lending Strategy. Please refer to the Risk Disclosure: Senior, Mezzanine and Junior Tranches Section for a detailed risk explanation.