What is 'Early Amortization'

Early amortization is an accelerated payment of bond principal to investors holding asset-backed security (ABS) products. Early amortization is also called an early call or a payout event.

BREAKING DOWN 'Early Amortization'

Early amortization reduces the amount of time before an investor will receive the repayment of their principal from an asset-backed security (ABS) purchase. Typically, when an investor purchases a bond, they receive regularly scheduled interest payments over a set period, or until the maturity of the bond. At the point of bond maturity, the investor gets back the full value of the bond principal and interest payments cease.

Asset-backed securities (ABS) are financial securities that are collateralized by a pool of underlying assets such as loans, leases, credit card debt and other receivables. For example, a bank might bundle car loans on which they collect interest and sell them to finance future car loans. Assets like these are usually illiquid and can not sell on their own accord. However, the process of securitization makes them marketable to investors. 

Early amortization will mean a liquidity crisis for the bond originator, as funding dries up. The event is usually triggered if there is a sudden increase in delinquencies in the underlying loans. Other early amortization triggers for asset-backed securities include:

  • The bond’s sponsor, such as a bank, or servicer declaring bankruptcy
  • Insufficient payments from underlying borrowers
  • Inadequate excess spread, or low remaining interest payments and other collected fees on the security after covering expenses
  • Default rate rises above an acceptable level

When early amortization occurs, it cannot be reversed or rescinded, and all bond principal and interest payments go to investors regardless of a bond’s expected maturity date.

How Early Amortization Affects Investors

Rating agencies typically require asset-backed securities to include language in their contracts about early amortization to receive a debt rating. This language is needed because the payout from an early amortization event helps protect investors from prolonged exposure to receivables with deteriorated credit performance. Investors should be aware that while early amortization helps mitigate the risk involved with investing in asset-backed securities, it does not eliminate it. There is still the risk that investors will not earn all of the promised interest from the security if an early amortization event is triggered.

The cash flow of asset-backed securities is not always reliable. For that reason, they are not sold with a guaranteed maturity date, but instead, with an average maturity. Early amortization can help protect investors if the bond’s maturity is cut short.

RELATED TERMS
  1. Amortized Bond

    A financial certificate that has been reduced in value for records ...
  2. Amortization

    Amortization is an accounting technique used to incrementally ...
  3. Negative Amortization Limit

    A provision in certain loan contracts that limits the amount ...
  4. Negatively Amortizing Loan

    A negatively amortizing loan is a loan where the payments made ...
  5. Amortizable Bond Premium

    Amortizable bond premium is a tax term referring to the excess ...
  6. Corporate Bond

    A corporate bond is a debt security issued by a corporation and ...
Related Articles
  1. Investing

    Premium Bonds: Problems And Opportunities

    Learn all about premium bonds and how you can make them work for you.
  2. Investing

    Corporate Bonds: Advantages and Disadvantages

    Corporate bonds can provide compelling returns, even in low-yield environments. But they are not without risk.
  3. Investing

    Why Bond Prices Fall When Interest Rates Rise

    Never invest in something you don’t understand. Bonds are no exception.
  4. Investing

    Key Strategies To Avoid Negative Bond Returns

    It is difficult to make money in bonds in a rising rate environment, but there are ways to avoid losses.
  5. Investing

    Taxation Rules for Bond Investors

    To sum-up there are three types of bonds: government bonds, municipal bonds, and corporate bonds. Find out how each of these bonds are taxed and what you can do as an investor.
  6. Investing

    Advanced Bond Concepts

    Learn the complex concepts and calculations for trading bonds including bond pricing, yield, term structure of interest rates and duration.
  7. Retirement

    Money Market vs. Short-Term Bonds: A Compare and Contrast Case Study

    Discover characteristics of money market and short-term bonds, including how the investments are alike and different, and the benefits and risks each offers.
RELATED FAQS
  1. What does amortization mean in the context of a pension plan?

    Discover when and why accountants use amortization techniques in the context of pension plans, and why those changes help ... Read Answer >>
Hot Definitions
  1. Discount Rate

    Discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from ...
  2. Economies of Scale

    Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
  3. Quick Ratio

    The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
  4. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  5. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  6. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
Trading Center