Collateral valuation adjustments

Collateral valuation adjustment (ColVA) — also called an appraisal subordination entitlement reduction (ASER) — is a structuring mechanism used in commercial mortgage-backed security (CMBS) deals to protect senior tranches by adjusting cash flows when collateral valuation declines.^[1]

ColVA/ASER was introduced in response to rating agency concerns that, without such a mechanism, cash flow from mortgage loans likely to default would still be paid to lower (first-loss) tranches. The adjustment imposes a notional reduction on the value of collateral in distress, redirecting cash flow away from subordinate classes toward protecting senior bondholders.^[2]

The primary objective is to maintain the credit rating of senior tranches by reducing payments to junior investors when collateral value falls.^[3]

Mechanism

When a CMBS pool loan becomes distressed and updated appraisal reveals a value decline, a Collateral Valuation Adjustment is applied. Key aspects:

• The size of the adjustment is based on the difference between the loan balance and the appraised collateral value.
• The notional reduction reduces cash flow allocations to subordinate tranches.
• Senior tranches continue to receive payments, helping preserve credit support.
• If collateral values recover or losses differ from estimates, the adjustment can be reversed or modified.

See also

• Residential mortgage-backed security
• Credit enhancement
• Tranche
• Real estate mortgage investment conduit