What is a Calamity Call
A calamity call is a protective call feature found in a collateralized mortgage obligation (CMO). If the cash flow generated by the underlying collateral is not enough to support the scheduled principal and interest payments, either because of loan defaults or prepayment, then the issuer will retire a portion of the CMO. It is designed primarily to reduce the issuer's reinvestment risk.
A clean-up call is another name for a calamity call.
BREAKING DOWN Calamity Call
A collateralized mortgage obligation (CMO), is a security which is backed by a pool of mortgages, also sometimes known as Real Estate Mortgage Investment Conduits (REMICs). Investors utilize CMOs to gain access to mortgage cash flows without originating, or purchasing, the mortgages themselves. CMOs garner cash flow as the borrowers repay their mortgages, and this repayment serves as collateral. The collateralized mortgage obligation (CMO) provides income for the investors from the principal and interest. A calamity call provision provides built-in protection for the CMO investors and guarantees their income flow is uninterrupted. The calamity, or clean-up, call reduces the risk of default while also protecting the issuer from reinvestment risk.
A calamity call is one type of protection used in CMOs. Other types of protection include over-collateralization and pool insurance. In addition to protecting against reinvestment risk, calamity calls can be used to protect against default losses. They may be used in CMOs structured from second lien mortgages, where limited protection is available against default losses. For conventional fixed-rate mortgages, over-collateralization may provide sufficient protection to the underlying pool of mortgages.
In some circumstances, a calamity call references a type of extraordinary redemption provision, usually found in municipal bonds. As an example, a calamity call can offset lost revenue from a municipal bond, issued to secure the construction of a community building, which later has significant damage limiting its ability to generate revenue. This kind of calamity call is also known as a catastrophe call.
Example of a Calamity Call
Company A issues a $10 million CMO that generates $500,000 each month from underlying mortgage interest and principal payments. When a significant number of the mortgage holders either default on their loans or prepay due to selling their homes before their mortgage being paid off, the CMO no longer produces enough income to pay its investors. Company A could then be required to retire part of the CMO to pay the investors.