Excellent Present at On on Financial Management of Structured Products
Content
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Collateralized Debt Obligations (CDOs) – Part 1 off 2
โครงการอบรม
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Important Note:
Financial Management of Structured Products
โดยสมาคมนกวเคราะหหลกทรพย สมาคมตลาดตราสารหนไทย สานกบรหารหนสาธารณะ กระทรวงการคลัง โดยสมาคมนักวิเคราะหหลักทรัพย สมาคมตลาดตราสารหนี้ไทย และ สํานักบริหารหนี้สาธารณะ กระทรวงการคลง
Bangkok Convention Centre at CentralWorld September 27, 2007
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Sombat Jiwariyavej Product Development, Treasury Group, Siam Commercial Bank
This presentation is prepared for information and discussion purposes only. It does not represent or constitute an advice, offer, recommendation or solicitation by us and should not be relied as such. We assume no responsibility for this presentation. You are advised to make your own independent judgment with respect to all matters contained herein.
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Contents
1. Introduction to Securitization 2. Introduction to CDOs 3. Credit Derivatives 3 • Definition • Credit Default Swap: A Building Block of Synthetic CDO IS A erivatives efinition • ISDA Credit Derivatives Definition 4. CDO Structures • Balance Sheet CDO, STCDO, CDO^2, ABSCDO, Hybrid CDO
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Securitization
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Introduction to Securitization
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Definition of Securitization
“Securitization is a financing process in which a corporate entity moves assets, to an ostensibly bankruptcy-remote / low risk vehicle, in order to obtain lower interest rates from potential lenders. This is obtained because the assets cannot be seized in a bankruptcy proceeding, the risk is less for lenders and they are willing to offer a lower rate. The technique comes under the umbrella of structured finance as it applies to assets that typically are illiquid contracts (i.e. assets that cannot easily be sold). It has evolved from tentative beginnings in the late 1970s to a vital funding source with an estimated total aggregate outstanding of $8.06 trillion (as of the end of 2005, by the Bond Market Association) and new issuance of $3.07 trillion in 2005 in the U.S. markets alone.”
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Source: Wikipedia.org
SPV does not engage in any business g activities other than owning receivables and issuing bonds to comply to SEC. It cannot have employee. Therefore, it hires professional 3rd parties to run the securitisation transaction
“Integral to the process of S “I l h f Securitization i the concept of "T ii i is h f "True S l " I i Sale". It is essential to recognize that the whole process of Securitization aims to have the originator of some asset sell off the asset without having continuing interest postsale. Securitization is an institutionalization of this aim.”
5
Sales of Credit Card Receivables
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DHR / TA/ CA Seller/ Originator
Cash Seller Loan Sub Loan
Transfer notification to cardholders is exempted. Cardholders can use the credit cards and make payment to KTC a s u s u a l.
Introduction to Securitization
Securitization Flow Diagram
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Bond Proceed
SPV
(Bond Issuer)
Debenture Holders
ยerform servicing function for SPV
Obligors
Installments
Servicer
Purchase of credit card receivables are settled into 3 pieces - Cash settlement (equal to Rated Bonds proceeds) - Seller Loan, ranking pari passu to Rated Bonds - Sub Loan, serving as Credit Enhancement by subordinating right to receive principal and interest after Rated Bond and Seller Loan
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Introduction to Securitization
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Internal Enhancem ment
Sample of ABS Waterfall
Holders of Rated Bonds and Seller Loan always receive cash flows from credit card receivables prior to Sub Loan holders
Collect tion
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Outstanding
AAA (ST)
AAA (ST) AAA (LT) AA A Sub loan
Seller Loan
Can be structured by: • Time tranching to fit investor investment horizon • Credit tranching to suit investor risk/return appitite • Bullet and amoritzing for structural efficiency Relative size depend on - expected loss - targeted ratings
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AAA (LT) AA A Sub Loan
Sub Loan absorbs first loss from credit card d f lt via: f dit d default i • Cash flows waterfall • Interest calculation on notional principal • Sub Loan write-down on receivable default
Sample of ABS Repayment Profile
Time
Loss
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Introduction to Securitization
fra
Seller Loan mitigates co-creditors risk (all receivables from the same cardholder must be sold to SPV) Liability can be extended longer than Li bilit b t d dl th asset life by “Revolving” mechanism
Same rating but different tenors (time tranching)
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Same tenor but different ratings (credit tranching)
.or
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Introduction to Securitization
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Benefits of Securitization
Diversify Source of Fund
• New funding platform in addition to corporate bond and BE
Reduce Cost of Fund
• Can be enhanced to achieve higher rating than Seller/Originator corporate rating
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Securitization
• SPV Rated Bonds is not consolidated to Originator/Seller
• Debenture tenor flexibility (time tranching) • Debenture amortizing profile flexibility • Self-finance redemption
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Off-balance Sheet
Debt Profile Management
9
Any current or future cash flow that is generated by assets can be securitized. The most common types of asset include:
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Credit Card Receivable Automobile Loan/Purchase Residential/Commercial Mortgage
re
Introduction to Securitization
Samples of Securitized Assets
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Aircraft Lease Equipment Lease
Bond
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Bank Loan
.or
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Introduction to Securitization
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Categorization by Asset Types
ABS
Credit Cards, Auto Loans, Future Flows, Trade Receivables, etc.
Cash CDOs f C h CDO of Bank Loans, Bonds, SME Loans, Corp Credit.
Synthetic CDOs y (not necessarily considered Securitization)
CDO
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MBS
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Subprime (B&C) M t S b i Mortgages, Home Equity Loans, 1st Mortgage (A, Alt-A, Jumbo) HELOC, etc Commercial Mortgage
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CDOs
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Introduction to CDOs
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Definition of CDOs
Collateralized debt obligations (CDOs) are a type of asset-backed security or structured finance product. At a high level, a CDO can be thought of as a mutual fund where the owners (i.e. the equity class(es)) leverage their investment by borrowing (by issuing debt) against the portfolio. The term CDO is often used as a generic term that includes: portfolio
• • • • • • • Collateralized bond obligations (CBOs) -- CDOs backed primarily by bonds Collateralized loan obligations (CLOs) -- CDOs backed primarily by leveraged loans Structured finance CDOs (SFCDOs) -- CDOs backed primarily by asset-backed securities Collateralized mortgage obligation (CMOs) -- CDOs backed primarily by residential or commercial mortgages. Commercial Real Estate CDOs (CRE CDOs) -- backed primarily by real estate assets CDO-Squared -- CDOs backed primarily by securities issued by other CDO vehicles. CDO n CDO^n -- Generic term for CDO^3 (CDO cubed) and higher, where the CDO is backed by other CDO 3 higher CDOs/CDO^2/CDO^3. These are particularly difficult vehicles to model due to the possible repetition of exposures in the underlying. CPDO --Constant Proportion Debt Obligation -- backed by an index of debt securities (such as CDX or Itraxx but could be deal specific) which is periodically rolled, thus introducing market risk through the rollover. The leverage of the CPDO is periodically re-adjusted to match asset and liability spread.
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Source: Wikipedia.org Balance Sheet CDOs are structured for Seller’s credit risk management and regulatory capital purpose. Cash CDOs use funding from CDO Notes issuance to purchase physical assets, e.g. assets e g bonds or loans. Cashflow CDOs intend to repay CDO Notes by using interest and principal repayments from assets.
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A CDO primarily categorized by the features relating to the transaction’s asset pool. The main categories are Cashflow vs Money Market, Balance Sheet vs Arbitrage and Cash vs Synthetic CDOs
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Manageability
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Purpose Funding
Introduction to CDOs
Categorization of CDOs
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Arbitrage CDOs are structured to arbitrage higher yield assets and diversification benefit over the CDO issuances. Synthetic CDOs gain credit exposure by entering into Credit Default Swap contract. D f lt S t t
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Money Market CDOs intend to make gain from actively trading on changes in market value of assets.
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Introduction to CDOs
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Cashflow CDOs: Where cash flows from pool of assets payoff investors (similar to ABS)
Collateral Manager Class A Class B : : Equity
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Asset 1 Asset 2 Asset 3 : : Asset N
SPV
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Hedge Provider
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Credit Derivatives
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Credit Derivatives
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Definition
A Credit Derivative is a contract to transfer the risk of the total return of a credit asset falling below an agreed level, without transfer of the underlying asset. This is usually h f f h d l h ll achieved by transferring risk on a credit reference asset. It is designed to allow independent trading and hedging of credit risk. Early forms of credit derivatives were financial guarantees. Some common forms of credit derivatives are total return swap, credit default swap and credit linked notes.
Source: Wikipedia.org
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• Synthetic hedging instruments to reduce credit risk exposure • Gain access to borrowers who are not active in public markets, and improve portfolio diversifications • Create new assets tailor made to specific credit requirements not available in market, e.g. maturity
• Structure to enhance yield, e.g. Ith-to-Default basket • Simplify “Relative Value Trading” in credit market • Document with Standardized ISDA Template
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Credit Derivatives
Advantages of Credit Derivatives
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Credit Derivatives
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Credit Default Swap: Building Block of Synthetic CDO
CDS enables protection buyer to hedge against default, but g g not against changes in credit quality (i.e. credit spread) of the reference entity.
Reference Entity
Reference CDS Premium
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• • •
Protection Buyer
Protection Seller
Credit Event occurs Buyer deliver defaulted bond B d li d f lt d b d
Physical Settlement
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Or Cash Settlement
Seller pays full notional amount
Seller pays loss amount
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Key Concept: If a Credit Event occurs before the Scheduled Termination Date with respect to a Reference Entity or an Obligation and the Conditions to Payment are satisfied, then Cash Settlement or Physical Settlement will apply. Provides base template for credit derivative instruments Defines types of “Credit Event” on reference entity Defines Obligation Categories and Characteristics for purposes of Credit Events and settlement
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ISDA Credit Derivatives Definition
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Credit Derivatives
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Credit Derivatives
80 60 40 20 0
Aug-06
Dec-06
Nov-06
Aug-07
Oct-06
Sep-06
Feb-07
Apr-07
Jan-07
May-07
Mar-07
Sep-07
Jun-07
Jul-07
Basis Points per annum m
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Bondholder
Defaulted Bond
5-year USD CDS Premium
120 ATC KOT PTTCH PTT TOP 100
Credit-Linked Notes: An Application of CDS
T+Credit Spread
Liquidation Proceed Li id ti P d
Reference on Defaulted Bond Price as Recovery Rate T +CDS P CDS Premium i
B/E Holder
Recovery
In theory, cash bond can be replicated using Credit-Linked Note Structure, and assume away all counterparty B/E issuer risks
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Credit Derivatives
fra
CDS Premium T
Bond Issuer
Reference on Credit Event
CDS Counterparty
B/E Issuer
Risk-Free Bond
ud
Loss
=(1-Recovery)
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Synthetic Balance Sheet CDO structure employs CDS and enables bond/loan originator to raise funding against loans portfolio without having to transfer ownership of the loans. Senior CLO Investor Junior CLO Investor
RF Rate Proceed CDS Premium Cash Settlement Issuer pays recovery amount
CDO Structures
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(Funded) Synthetic Balance Sheet CDOs
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CLO Issuer
Risk-Free Asset
Credit Event occurs
CDO Structures
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CDS Premium Reference Issuer pays Loss amount
Originator
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Reference Bonds/Loans Portfolio
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CDO Structures
RF Ra ate
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(Funded) Synthetic Arbitrage CDOs
Synthetic Arbitrage CDO structure employs traded CDS and enables CLN investors to do credit arbitrage on the selected set of credits by leveraging on the capital structure of the transaction. CDO Issuer Portfolio CDS Counterparty
Reference
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Credit Protection Buyer
Mezzanie
Proceed CDS Premium RF Rate
CDS Premium
Risk-Free Asset
Reference Portfolio
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Cash Settlement
Credit Event occurs Issuer pays Loss amount
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Issuer pays recovery amount
Credit Default Swap
Reference Pool
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Payments Flow in Synthetic CDOs
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SPV Collateral
CDO Structures
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Coupon Notes
Premium
Credit Protection Seller
Proceeds
Credit Event Payments
Principal Repayment
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Example of a funded synthetic CDO
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CDO Structures
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(Unfunded) Synthetic CDOs
Premium
Credit Protection Buyer
Credit Default Swap
Credit Protection Seller
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Credit Event Payments
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Reference Pool
Reference Pool
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Ref. Entity 1 Ref. Entity 2 Ref. Entity 3 : : Ref. Entity N y
Loss
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A Sample Single Tranche CDO (STCDO)
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CDO Structures
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CDO Liability Virtual Tranche
Target Loss Tranche T Loss h
Loss
Loss Virtual Tranche Loss
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“Detachment Point”
“Attachment Point”
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CDO Structures CDO-Squared: a More Complex Correlation Intensive Structure
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CDO^2
Target Tranche
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1st Level “Virtual” CDOs
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~20%-30% Par 20% 30% ~100% Risk ~A-Aa tranches Reference Pool
Reference Pool
LOSSES
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g Target Tranche
CDO Structures
Another Common CDO^2 Structure
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~70%-80% Par 70% 80% ~0% Risk
Aaa ABS Reference Pool
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CDO Structures ABSCDO repackages RMBS enabling further arbitrage (leverage)
Mtg 1 Mtg 2 Mtg 3 Mt : : Mtg N
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RMBS Class A
SPV
RMBS Class B : : Subordinate RMBS Class A RMBS Class B : : Subordinate
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Mtg 1 Mtg 2 Mtg 3 : : Mtg N
SPV
RMBS Cl.B RMBS Cl.B RMBS Cl.B : : RMBS Cl.B
SPV CDO Mezz : :
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Key Differences between Cashflow and Synthetic CDOs • Assets Pool • True Sales • CDS vs cash assets: Credit Events, WAL • Ramp-up period • Transaction Structure • OC/IC Triggers • Reinvestment Period • Collateral Assets in Synthetic CDOs
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CDO Structures
Cash versus Synthetic CDOs
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CDO Structures
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Source: Fitch
Hybrid CDO
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Key Characteristics: • Asset pool consists of both synthetic (mostly referencing RMBS) and cash (predominantly ABS) assets. To date, the mix has been around 60-80% y synthetic RMBS, while the rest are cash ABS. • Liability structure consists of unfunded super-senior revolver (sized approximately matching total size of synthetic assets. SS is supported by various classes of senior and sub cash notes. Key Benefits: • Reduced ramp-up, reinvestment, Available Fund Caps risks Key Mechanism: • Loss occurs in synthetic asset is first covered by drawing on SS revolver, and revolver later expected repayment from cash assets. Key Risks: • Repayment from cash assets does not cover drawn SS, due to prepayment and loss timing mismatch between cash and synthetic assets.
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CDO Structures
Hybrid Cash + Synthetic CDOs
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www.scb.co.th
Contact
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Sombat Jiwariyavej, +66.2544.2178, [email protected]
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Collateralized Debt Obligations (CDOs) – Part 1 off 2
โครงการอบรม
w.
Important Note:
Financial Management of Structured Products
โดยสมาคมนกวเคราะหหลกทรพย สมาคมตลาดตราสารหนไทย สานกบรหารหนสาธารณะ กระทรวงการคลัง โดยสมาคมนักวิเคราะหหลักทรัพย สมาคมตลาดตราสารหนี้ไทย และ สํานักบริหารหนี้สาธารณะ กระทรวงการคลง
Bangkok Convention Centre at CentralWorld September 27, 2007
lo 4c
Sombat Jiwariyavej Product Development, Treasury Group, Siam Commercial Bank
This presentation is prepared for information and discussion purposes only. It does not represent or constitute an advice, offer, recommendation or solicitation by us and should not be relied as such. We assume no responsibility for this presentation. You are advised to make your own independent judgment with respect to all matters contained herein.
su re fra ud .or
2
g
1
ww
Contents
1. Introduction to Securitization 2. Introduction to CDOs 3. Credit Derivatives 3 • Definition • Credit Default Swap: A Building Block of Synthetic CDO IS A erivatives efinition • ISDA Credit Derivatives Definition 4. CDO Structures • Balance Sheet CDO, STCDO, CDO^2, ABSCDO, Hybrid CDO
3
w.
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su re fra
Securitization
ud .or
4
g
2
Introduction to Securitization
ww
Definition of Securitization
“Securitization is a financing process in which a corporate entity moves assets, to an ostensibly bankruptcy-remote / low risk vehicle, in order to obtain lower interest rates from potential lenders. This is obtained because the assets cannot be seized in a bankruptcy proceeding, the risk is less for lenders and they are willing to offer a lower rate. The technique comes under the umbrella of structured finance as it applies to assets that typically are illiquid contracts (i.e. assets that cannot easily be sold). It has evolved from tentative beginnings in the late 1970s to a vital funding source with an estimated total aggregate outstanding of $8.06 trillion (as of the end of 2005, by the Bond Market Association) and new issuance of $3.07 trillion in 2005 in the U.S. markets alone.”
w.
lo 4c
Source: Wikipedia.org
SPV does not engage in any business g activities other than owning receivables and issuing bonds to comply to SEC. It cannot have employee. Therefore, it hires professional 3rd parties to run the securitisation transaction
“Integral to the process of S “I l h f Securitization i the concept of "T ii i is h f "True S l " I i Sale". It is essential to recognize that the whole process of Securitization aims to have the originator of some asset sell off the asset without having continuing interest postsale. Securitization is an institutionalization of this aim.”
5
Sales of Credit Card Receivables
su re
DHR / TA/ CA Seller/ Originator
Cash Seller Loan Sub Loan
Transfer notification to cardholders is exempted. Cardholders can use the credit cards and make payment to KTC a s u s u a l.
Introduction to Securitization
Securitization Flow Diagram
fra ud
Bond Proceed
SPV
(Bond Issuer)
Debenture Holders
ยerform servicing function for SPV
Obligors
Installments
Servicer
Purchase of credit card receivables are settled into 3 pieces - Cash settlement (equal to Rated Bonds proceeds) - Seller Loan, ranking pari passu to Rated Bonds - Sub Loan, serving as Credit Enhancement by subordinating right to receive principal and interest after Rated Bond and Seller Loan
.or
6
g
3
Introduction to Securitization
ww
Internal Enhancem ment
Sample of ABS Waterfall
Holders of Rated Bonds and Seller Loan always receive cash flows from credit card receivables prior to Sub Loan holders
Collect tion
w.
Outstanding
AAA (ST)
AAA (ST) AAA (LT) AA A Sub loan
Seller Loan
Can be structured by: • Time tranching to fit investor investment horizon • Credit tranching to suit investor risk/return appitite • Bullet and amoritzing for structural efficiency Relative size depend on - expected loss - targeted ratings
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AAA (LT) AA A Sub Loan
Sub Loan absorbs first loss from credit card d f lt via: f dit d default i • Cash flows waterfall • Interest calculation on notional principal • Sub Loan write-down on receivable default
Sample of ABS Repayment Profile
Time
Loss
7
su re
Introduction to Securitization
fra
Seller Loan mitigates co-creditors risk (all receivables from the same cardholder must be sold to SPV) Liability can be extended longer than Li bilit b t d dl th asset life by “Revolving” mechanism
Same rating but different tenors (time tranching)
ud
Same tenor but different ratings (credit tranching)
.or
8
g
4
Introduction to Securitization
ww
Benefits of Securitization
Diversify Source of Fund
• New funding platform in addition to corporate bond and BE
Reduce Cost of Fund
• Can be enhanced to achieve higher rating than Seller/Originator corporate rating
w.
Securitization
• SPV Rated Bonds is not consolidated to Originator/Seller
• Debenture tenor flexibility (time tranching) • Debenture amortizing profile flexibility • Self-finance redemption
lo 4c
Off-balance Sheet
Debt Profile Management
9
Any current or future cash flow that is generated by assets can be securitized. The most common types of asset include:
su
Credit Card Receivable Automobile Loan/Purchase Residential/Commercial Mortgage
re
Introduction to Securitization
Samples of Securitized Assets
fra
Aircraft Lease Equipment Lease
Bond
ud
Bank Loan
.or
10
g
5
Introduction to Securitization
ww
Categorization by Asset Types
ABS
Credit Cards, Auto Loans, Future Flows, Trade Receivables, etc.
Cash CDOs f C h CDO of Bank Loans, Bonds, SME Loans, Corp Credit.
Synthetic CDOs y (not necessarily considered Securitization)
CDO
w.
MBS
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Subprime (B&C) M t S b i Mortgages, Home Equity Loans, 1st Mortgage (A, Alt-A, Jumbo) HELOC, etc Commercial Mortgage
11
su re fra
CDOs
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12
g
6
Introduction to CDOs
ww
Definition of CDOs
Collateralized debt obligations (CDOs) are a type of asset-backed security or structured finance product. At a high level, a CDO can be thought of as a mutual fund where the owners (i.e. the equity class(es)) leverage their investment by borrowing (by issuing debt) against the portfolio. The term CDO is often used as a generic term that includes: portfolio
• • • • • • • Collateralized bond obligations (CBOs) -- CDOs backed primarily by bonds Collateralized loan obligations (CLOs) -- CDOs backed primarily by leveraged loans Structured finance CDOs (SFCDOs) -- CDOs backed primarily by asset-backed securities Collateralized mortgage obligation (CMOs) -- CDOs backed primarily by residential or commercial mortgages. Commercial Real Estate CDOs (CRE CDOs) -- backed primarily by real estate assets CDO-Squared -- CDOs backed primarily by securities issued by other CDO vehicles. CDO n CDO^n -- Generic term for CDO^3 (CDO cubed) and higher, where the CDO is backed by other CDO 3 higher CDOs/CDO^2/CDO^3. These are particularly difficult vehicles to model due to the possible repetition of exposures in the underlying. CPDO --Constant Proportion Debt Obligation -- backed by an index of debt securities (such as CDX or Itraxx but could be deal specific) which is periodically rolled, thus introducing market risk through the rollover. The leverage of the CPDO is periodically re-adjusted to match asset and liability spread.
w.
•
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Source: Wikipedia.org Balance Sheet CDOs are structured for Seller’s credit risk management and regulatory capital purpose. Cash CDOs use funding from CDO Notes issuance to purchase physical assets, e.g. assets e g bonds or loans. Cashflow CDOs intend to repay CDO Notes by using interest and principal repayments from assets.
13
A CDO primarily categorized by the features relating to the transaction’s asset pool. The main categories are Cashflow vs Money Market, Balance Sheet vs Arbitrage and Cash vs Synthetic CDOs
su
Manageability
re
Purpose Funding
Introduction to CDOs
Categorization of CDOs
fra
Arbitrage CDOs are structured to arbitrage higher yield assets and diversification benefit over the CDO issuances. Synthetic CDOs gain credit exposure by entering into Credit Default Swap contract. D f lt S t t
ud
Money Market CDOs intend to make gain from actively trading on changes in market value of assets.
.or
14
g
7
Introduction to CDOs
ww
Cashflow CDOs: Where cash flows from pool of assets payoff investors (similar to ABS)
Collateral Manager Class A Class B : : Equity
w.
Asset 1 Asset 2 Asset 3 : : Asset N
SPV
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Hedge Provider
15
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Credit Derivatives
fra
ud
.or
16
g
8
Credit Derivatives
ww
Definition
A Credit Derivative is a contract to transfer the risk of the total return of a credit asset falling below an agreed level, without transfer of the underlying asset. This is usually h f f h d l h ll achieved by transferring risk on a credit reference asset. It is designed to allow independent trading and hedging of credit risk. Early forms of credit derivatives were financial guarantees. Some common forms of credit derivatives are total return swap, credit default swap and credit linked notes.
Source: Wikipedia.org
17
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• Synthetic hedging instruments to reduce credit risk exposure • Gain access to borrowers who are not active in public markets, and improve portfolio diversifications • Create new assets tailor made to specific credit requirements not available in market, e.g. maturity
• Structure to enhance yield, e.g. Ith-to-Default basket • Simplify “Relative Value Trading” in credit market • Document with Standardized ISDA Template
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Credit Derivatives
Advantages of Credit Derivatives
fra
ud
.or
18
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9
Credit Derivatives
ww
Credit Default Swap: Building Block of Synthetic CDO
CDS enables protection buyer to hedge against default, but g g not against changes in credit quality (i.e. credit spread) of the reference entity.
Reference Entity
Reference CDS Premium
w.
• • •
Protection Buyer
Protection Seller
Credit Event occurs Buyer deliver defaulted bond B d li d f lt d b d
Physical Settlement
lo 4c
Or Cash Settlement
Seller pays full notional amount
Seller pays loss amount
19
Key Concept: If a Credit Event occurs before the Scheduled Termination Date with respect to a Reference Entity or an Obligation and the Conditions to Payment are satisfied, then Cash Settlement or Physical Settlement will apply. Provides base template for credit derivative instruments Defines types of “Credit Event” on reference entity Defines Obligation Categories and Characteristics for purposes of Credit Events and settlement
su
ISDA Credit Derivatives Definition
re
Credit Derivatives
fra
ud .or
20
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10
Credit Derivatives
80 60 40 20 0
Aug-06
Dec-06
Nov-06
Aug-07
Oct-06
Sep-06
Feb-07
Apr-07
Jan-07
May-07
Mar-07
Sep-07
Jun-07
Jul-07
Basis Points per annum m
21 22
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Bondholder
Defaulted Bond
5-year USD CDS Premium
120 ATC KOT PTTCH PTT TOP 100
Credit-Linked Notes: An Application of CDS
T+Credit Spread
Liquidation Proceed Li id ti P d
Reference on Defaulted Bond Price as Recovery Rate T +CDS P CDS Premium i
B/E Holder
Recovery
In theory, cash bond can be replicated using Credit-Linked Note Structure, and assume away all counterparty B/E issuer risks
su re
Credit Derivatives
fra
CDS Premium T
Bond Issuer
Reference on Credit Event
CDS Counterparty
B/E Issuer
Risk-Free Bond
ud
Loss
=(1-Recovery)
.or g
11
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Synthetic Balance Sheet CDO structure employs CDS and enables bond/loan originator to raise funding against loans portfolio without having to transfer ownership of the loans. Senior CLO Investor Junior CLO Investor
RF Rate Proceed CDS Premium Cash Settlement Issuer pays recovery amount
CDO Structures
23
su
(Funded) Synthetic Balance Sheet CDOs
re
CLO Issuer
Risk-Free Asset
Credit Event occurs
CDO Structures
fra
CDS Premium Reference Issuer pays Loss amount
Originator
ud
Reference Bonds/Loans Portfolio
.or
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CDO Structures
RF Ra ate
ww
(Funded) Synthetic Arbitrage CDOs
Synthetic Arbitrage CDO structure employs traded CDS and enables CLN investors to do credit arbitrage on the selected set of credits by leveraging on the capital structure of the transaction. CDO Issuer Portfolio CDS Counterparty
Reference
w.
Credit Protection Buyer
Mezzanie
Proceed CDS Premium RF Rate
CDS Premium
Risk-Free Asset
Reference Portfolio
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Cash Settlement
Credit Event occurs Issuer pays Loss amount
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Issuer pays recovery amount
Credit Default Swap
Reference Pool
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Payments Flow in Synthetic CDOs
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SPV Collateral
CDO Structures
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Coupon Notes
Premium
Credit Protection Seller
Proceeds
Credit Event Payments
Principal Repayment
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Example of a funded synthetic CDO
.or
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g
13
CDO Structures
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(Unfunded) Synthetic CDOs
Premium
Credit Protection Buyer
Credit Default Swap
Credit Protection Seller
w.
Credit Event Payments
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Reference Pool
Reference Pool
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Ref. Entity 1 Ref. Entity 2 Ref. Entity 3 : : Ref. Entity N y
Loss
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A Sample Single Tranche CDO (STCDO)
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CDO Structures
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CDO Liability Virtual Tranche
Target Loss Tranche T Loss h
Loss
Loss Virtual Tranche Loss
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“Detachment Point”
“Attachment Point”
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CDO Structures CDO-Squared: a More Complex Correlation Intensive Structure
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CDO^2
Target Tranche
w.
1st Level “Virtual” CDOs
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~20%-30% Par 20% 30% ~100% Risk ~A-Aa tranches Reference Pool
Reference Pool
LOSSES
29
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g Target Tranche
CDO Structures
Another Common CDO^2 Structure
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~70%-80% Par 70% 80% ~0% Risk
Aaa ABS Reference Pool
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CDO Structures ABSCDO repackages RMBS enabling further arbitrage (leverage)
Mtg 1 Mtg 2 Mtg 3 Mt : : Mtg N
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RMBS Class A
SPV
RMBS Class B : : Subordinate RMBS Class A RMBS Class B : : Subordinate
w.
Mtg 1 Mtg 2 Mtg 3 : : Mtg N
SPV
RMBS Cl.B RMBS Cl.B RMBS Cl.B : : RMBS Cl.B
SPV CDO Mezz : :
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Key Differences between Cashflow and Synthetic CDOs • Assets Pool • True Sales • CDS vs cash assets: Credit Events, WAL • Ramp-up period • Transaction Structure • OC/IC Triggers • Reinvestment Period • Collateral Assets in Synthetic CDOs
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CDO Structures
Cash versus Synthetic CDOs
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g
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CDO Structures
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Source: Fitch
Hybrid CDO
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Key Characteristics: • Asset pool consists of both synthetic (mostly referencing RMBS) and cash (predominantly ABS) assets. To date, the mix has been around 60-80% y synthetic RMBS, while the rest are cash ABS. • Liability structure consists of unfunded super-senior revolver (sized approximately matching total size of synthetic assets. SS is supported by various classes of senior and sub cash notes. Key Benefits: • Reduced ramp-up, reinvestment, Available Fund Caps risks Key Mechanism: • Loss occurs in synthetic asset is first covered by drawing on SS revolver, and revolver later expected repayment from cash assets. Key Risks: • Repayment from cash assets does not cover drawn SS, due to prepayment and loss timing mismatch between cash and synthetic assets.
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CDO Structures
Hybrid Cash + Synthetic CDOs
fra
ud
.or
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g
17
ww w.
www.scb.co.th
Contact
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Sombat Jiwariyavej, +66.2544.2178, [email protected]
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