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September 1, 2017

Understanding tranches

The word tranche is French for “slice” or “portion”. In the world of investing, it is used to describe a portion of a security that has been split up into smaller pieces, all of which may be available for investment at the same time but may have a different risk/reward ratio.
At LendInvest we commonly divide our loans into two tranches: Tranche A and Tranche B. Each tranche offers investors a fixed rate of return which reflects the Loan-to-Value. The tranche you choose to invest in denotes the order in which you’ll be repaid, should the borrower default on their loan payments. At LendInvest, Tranche A would always be paid first, giving those that have invested in Tranche B a higher return for the extra risk they’ve taken in their investment.

So what’s the difference?

Tranche A investors take on a lower level of risk and so stand to receive a lower rate of return than Tranche B investors.
An investor that chooses to invest in Tranche A will, in respect of each scheduled repayment of capital or income from a borrower, be paid in priority to a Tranche B investor. If a Tranche A payment is not made in full, no further payments to Tranche B investors will be received until all Tranche A payments are up to date. To reflect the priority in which tranche investors are paid (and therefore the additional risk), Tranche B investors will be entitled to receive a higher income rate for the same loan invested in.
For example:

Property Value £1,000,000
Loan £750,000
Loan to Value 75% LTV
Tranche A £500,000
Tranche to Value 50.00%
Tranche B £250,000
Tranche to Value 50.01-75.00%

In the above example, if a borrower failed to make any of his or her loan repayments, we would need to recover 50% of the property value in order to repay Tranche A investors. This is described as a Tranche to Value of 50.00%, because the first 50.00% of the property value is allocated towards this portion of investors.
To repay Tranche B investors in full, the next 50.01% upwards of the property value will go towards repaying Tranche B investors. This is described as a Tranche to Value of 50.01-75.00%, because the first 50.01% of the property value has already gone towards repaying Tranche A investors. The next 50.01-75.00% of the property value can therefore now go to the Tranche B cohort of investors.
The above example assumes that the full value of the property is recovered on enforcement. If the full value is not recovered, there may be an overall shortfall which could mean that investors are not repaid in full. Should this materialise, Tranche B investors would be at a higher risk than Tranche A investors in recovering their investment.
Depending on preference, our investors can use ‘auto-invest’ (a platform feature that allows you to be automatically invested into loans that match your exacting criteria) to select a tranche preference. If, for example, an investor chooses to select to only invest in the Tranche B portion of a loan, they would only be invested in loans that offered a Tranche B investment opportunity and would not be invested in those loans that are not tranched. 
To summarise, the difference between Tranche A and B becomes clear in a default situation. If a loan defaults Tranche A investors get paid first and Tranche B investors get paid second. In all tranches the security for the loan remains exactly the same because the underwriting process has been done for the whole loan.
To read more about the transparency of our borrowing processes, click here.