What is a Senior Tranche?
A senior tranche is the most protected layer in a structured finance product. Senior tranche holders receive payments before other investors and are last to absorb losses. This priority comes with a trade-off: lower yields compared to riskier tranches.
How Tranching Works
Structured products divide risk and return into layers (tranches):
- Senior Tranche: First to get paid, last to lose, lowest yield
- Mezzanine Tranche: Middle priority and yield
- Junior/Equity Tranche: Last paid, first loss, highest yield
Senior Tranche Characteristics
- Payment Priority: First claim on cash flows
- Loss Protection: Junior tranches absorb losses first
- Lower Yield: Typically 30-50% lower than junior
- Higher Rating: Often investment-grade equivalent
- Lower Volatility: More stable returns
Example in DeFi Credit
A $10M lending pool might structure as:
- $7M Senior (70%): 6% APY, protected by $3M junior
- $3M Junior (30%): 15% APY, absorbs first 30% of losses
If $1M defaults, junior absorbs it entirely. Senior is unaffected.
DeFi Protocols Using Tranching
- Centrifuge: DROP (senior) and TIN (junior) tokens
- Goldfinch: Senior Pool and Backer positions
- Maple: Some pools have junior capital from delegates
Who Invests in Senior Tranches?
- Risk-averse investors seeking capital preservation
- Institutions with fiduciary constraints
- Those seeking bond-like returns in DeFi
- Stablecoin treasury managers
Trade-offs
Senior tranches offer safety but:
- May underperform in low-default environments
- Limited upside potential
- Often have lock-up periods