A layer of loss absorption in a collateralized debt obligation (CDO) or any similar structures that absorbs initial losses (it provides the first level of protection against any defaults) and is by nature the lowest tranche in terms of seniority and priority in repayment. In other words, it represents a claim on all remaining cash flows after having repaid all the obligations for each senior and mezzanine tranches.
Equity tranche is perceived as the most junior (or junk, unrated) layer of protection. In a true sale transaction, the equity tranche (also called the first loss position, FLP) is usually not rated. All default losses of the underlying pool are allocated exclusively to that layer until it is exhausted. Any losses exceeding the ability of absorption of an equity tranche are allocated exclusively to the tranche with the next lowest rating until it is exhausted, then exclusively to the tranche with the next lowest rating, etc.
An equity tranche is also known as a residual tranche or a first-loss piece.
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