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Collateralized Debt Obligations Presentation Final Version!

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Presentation on Collateralized Debt Obligations

Presentation on Collateralized Debt Obligations


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  • 1. Collateralized Debt Obligations
    • “The Biology of CDOs”
    A General Overview of the Genus-JAMES
    • “Focus on a Species”
    Commercial Real Estate CDOs-TOM
  • 2. What Are Collateralized Debt Obligations (CDOs)?
    Type of SPE constructed to hold assets as collateral and to sell tranches of the cash flows derived from the underlying assets to “QIBs”
  • 3. The Taxonomy of CDOs
  • 4. Taxonomy Based on AssetsWhat are they made of?Debt Products That Create Cash Flow Streams
    • REIT Debt
    • 5. Mezzanine Debt
    • 6. Middle Market Loans
    • 7. Non-Performing Loans
    • 8. Distressed Debt and DIP Financings
    • 9. Non-funded Loan Commitments
    • 10. Forfaiting Assets (trade finance-related debt)
    • 11. Private Equity
    • 12. Hedge Funds
    • 13. Derivative Exposures
    • 14. Synthetic Securities
    • 15. High Yield Bonds
    • 16. Leveraged Bank Loans (both term and revolving)
    • 17. Investment Grade Bonds and Loans (both term and revolving)
    • 18. Emerging Market Sovereign Debt
    • 19. Emerging Market Corporate Debt
    • 20. Asset-Backed Securities (ABS) (including CDO securities)
    • 21. Mortgage-Backed Securities (MBS & CMBS)
    • 22. Project Finance Debt (bonds and loans)
  • Taxonomy Based on Sourceof Cash FlowsHow do the investors make money?
    • Cash Flow (Par Value)
    • 23. “Mark to Market ” eliminated through securitization
    • 24. Market Value
    • 25. More frequent trading to realize capital gains profits
  • Taxonomy Based on MotivationWho initiates the CDO?
    • Balance Sheet CDO
    • 26. Initiated by originators to remove assets from the balance sheet
    • 27. Arbitrage CDO
    • 28. Initiated by Investors
    • 29. Collateral Manager purchases assets from the market
  • Taxonomy Based on BehaviorHow do they respond to the assets?
    • Static CDO
    • 30. Assets held constant over the life of the transaction
    • 31. Managed CDO
    • 32. Manager employed to Monitor and Trade Assets
  • Taxonomy Based on RegionWhere do the assets come from?
  • The Lifecycle of CDOs
  • 39.
  • 40. The Anatomy of CDOs
  • 41. The Vital Organs of the CDO(The Individuals that make it function)
    • Issuers or Originators
    • 42. Investors
    • 43. Trustee or Custodian
    • 44. The Collateral Manager or Asset Manager
    • 45. Swaps Dealer or the Hedge Counterparty
    • 46. External Credit Enhancer or Bond Insurer
    • 47. Rating Agencies
    • 48. Underwriters
  • 49.
  • 50. The Symbiotic Relationship(The Rating Agencies)
    Primary Agencies
  • Ratings Agencies
    Key Rating Parameters
    • Asset correlation
    • 54. Default Probability
    • 55. Recovery Rate
    Pre-Sale Report
    • These reports are meant to outline strengths, concerns, characteristics, etc. of the deal in question before the deal is marketed to potential investors
    Indenture
    • Deals rated based on the relevant terms of the binding enforceable documents, primarily the Indenture
  • Ratings Process
    • On a monthly basis required information is sent from the Collateral Managers (CUSIP-based information including current enhancement levels; and loan-based information including default, delinquency, foreclosure, and future funding amounts etc); and on a quarterly basis, debt stacks and property information, including largest tenants, net operating income (NOI), net cash flow (NCF), debt service, occupancy, and reserve balances for each mortgaged property in a CRE CDO
    • 56. Moody’s utilizes a metric called a WARF score (Weighted Average Rating Factor) and D-Score (Diversification) to gauge the riskiness of the CDO Collateral
    • 57. In calculating the WARF, each asset is given a numerical ranking, which corresponds with its rating level, and indicates that asset’s theoretical default probability over a 10 year time frame
    • 58. In the past, Moody’s has used a fixed recovery rate by original tranche rating. Going forward they will use a floating recovery rate model that uses a mean recovery rate determined by the rating of the subject asset and that simulates a range of potential recovery rates around the mean. With this more robust approach, they expect to capture more of the tail risk associated with variability of recovery rates.
  • Commercial Real Estate (CRE ) CDOs
    • A CRE CDO, in its most basic form, is a bankruptcy remote, special purpose vehicle (SPV) created specifically to finance the purchase of CRE related assets (e.g., CMBS, REIT debt, whole loans, B- notes, mezzanine debt) that are funded by privately issuing liabilities (notes) and equity
    • 59. From a Rating Agency perspective, CRE CDOs are grouped into two general classifications; 1) CUSIP CDOs – which mainly consist of rated collateral such as CMBS and/or REIT and CREL CDOs which mostly contain unrated collateral such as whole loans, mezzanine loans and B-notes
    • 60. Early CDOs allowed B-piece buyers and special servicers to achieve higher leverage and greater diversity in their investments. Subordinate lenders often exercise great influence on the fortune of troubled CRE loans
    • 61. Newer CDOs have evolved into two somewhat distinct types: re-securitizations (CMBS bonds, CMBS B-pieces and REIT debt )vs first securitization (whole loan, B-Notes and mezzanine loans)
  • 62. Motivation for Creating a CRE CDO
    Issuers/Mangers/Sponsors
    • Can obtain low cost term-matched financing. Reduce the mismatch between the term of the trade and the average life of the underlying collateral. Traditional Repos or Lines of Credit can be expensive
    • 63. Non mark-to-market - No triggers that would require the borrower to post additional collateral. Significant advantage during volatile credit markets
    • 64. Significant flexibility regarding asset substitution/replenishment
    • 65. For Asset Mangers it creates portfolio diversity along with increased management fees
    • 66. Arbitrage – The gap between Collateral and Liability spreads
  • Motivation for Creating a CRE CDO
    Investors
    • Offer a way to gain access to an otherwise illiquid market
    • 67. Customized tranched risk (high/low investment grade notes). For example an insurance company will buy the senior tranche whereas the hedge fund may buy the subordinate tranche
  • Evolution of Collateral Composition
    1999-2003
    • Comprised of REIT debt, CMBS paper or a mix of both
    • 68. Were exclusively utilized by mortgage REIT and B-piece buyers
    2003-2009
    • B-Notes - Immediately subordinate to the investment-grade (and securitized) component of a first mortgage loan (Can be multi-tranched)
    • 69. CMBS
    • 70. Mezzanine Loans – A loan secured by a pledge of equity in the mortgage borrower. Subordinate to the A-note and B-note
    • 71. Whole Loans – Unrated and unsecured CMBS asset. Grouped into three types: stabilized, transitional (typically land projects) and developmental
    • 72. Credit Tenant Lease – A loan backed by the property’s rent payments
    • 73. Preferred Equity
    • 74. REIT Debt
    • 75. Rake Bonds – A junior participation or B-note that is held inside of a REMIC
    • 76. Synthetics (CDS)
    Recent CRE CDOs
    • Contain riskier assets such as condominium conversion, land and construction loans which are affected with a downturn in the economy
  • Sample Old vs New Collateral Composition
  • 77. Additional Examples of Collateral Evolution
  • 78. Basic Structure
  • 79. The Capital Structure
  • 80. Hypothetical Office Loan Structure
  • 81. CRE CDO Buyer Base
    The geographic distribution of CRE CDO is approximately 65% domestic investors and 35% international investors.
  • 82. CRE CDO vs CMBS
    CRE CDO spreads have been historically wider than the spreads of CMBS
    (A triple-A CRE CDO paper can offer 10bp to 30bp pickup over comparable rated CMBS)