Collateralized Debt Obligations Presentation Final Version!


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Collateralized Debt Obligations Presentation Final Version!

  1. 1. Collateralized Debt Obligations<br /><ul><li>“The Biology of CDOs”</li></ul>A General Overview of the Genus-JAMES<br /><ul><li>“Focus on a Species”</li></ul>Commercial Real Estate CDOs-TOM<br />
  2. 2. What Are Collateralized Debt Obligations (CDOs)?<br />Type of SPE constructed to hold assets as collateral and to sell tranches of the cash flows derived from the underlying assets to “QIBs”<br />
  3. 3. The Taxonomy of CDOs<br />
  4. 4. Taxonomy Based on AssetsWhat are they made of?Debt Products That Create Cash Flow Streams<br /><ul><li>REIT Debt
  5. 5. Mezzanine Debt
  6. 6. Middle Market Loans
  7. 7. Non-Performing Loans
  8. 8. Distressed Debt and DIP Financings
  9. 9. Non-funded Loan Commitments
  10. 10. Forfaiting Assets (trade finance-related debt)
  11. 11. Private Equity
  12. 12. Hedge Funds
  13. 13. Derivative Exposures
  14. 14. Synthetic Securities
  15. 15. High Yield Bonds
  16. 16. Leveraged Bank Loans (both term and revolving)
  17. 17. Investment Grade Bonds and Loans (both term and revolving)
  18. 18. Emerging Market Sovereign Debt
  19. 19. Emerging Market Corporate Debt
  20. 20. Asset-Backed Securities (ABS) (including CDO securities)
  21. 21. Mortgage-Backed Securities (MBS & CMBS)
  22. 22. Project Finance Debt (bonds and loans)</li></li></ul><li>Taxonomy Based on Sourceof Cash FlowsHow do the investors make money?<br /><ul><li>Cash Flow (Par Value)
  23. 23. “Mark to Market ” eliminated through securitization
  24. 24. Market Value
  25. 25. More frequent trading to realize capital gains profits</li></li></ul><li>Taxonomy Based on MotivationWho initiates the CDO?<br /><ul><li>Balance Sheet CDO
  26. 26. Initiated by originators to remove assets from the balance sheet
  27. 27. Arbitrage CDO
  28. 28. Initiated by Investors
  29. 29. Collateral Manager purchases assets from the market</li></li></ul><li>Taxonomy Based on BehaviorHow do they respond to the assets?<br /><ul><li>Static CDO
  30. 30. Assets held constant over the life of the transaction
  31. 31. Managed CDO
  32. 32. Manager employed to Monitor and Trade Assets</li></li></ul><li>Taxonomy Based on RegionWhere do the assets come from?<br /><ul><li>U.S. High Yield CDOs
  33. 33. European CDOs
  34. 34. Emerging Market CDOs
  35. 35. Asian CDOs
  36. 36. Japanese CDOs
  37. 37. Korean CDOs
  38. 38. Etc.</li></li></ul><li>The Lifecycle of CDOs<br />
  39. 39.
  40. 40. The Anatomy of CDOs<br />
  41. 41. The Vital Organs of the CDO(The Individuals that make it function)<br /><ul><li>Issuers or Originators
  42. 42. Investors
  43. 43. Trustee or Custodian
  44. 44. The Collateral Manager or Asset Manager
  45. 45. Swaps Dealer or the Hedge Counterparty
  46. 46. External Credit Enhancer or Bond Insurer
  47. 47. Rating Agencies
  48. 48. Underwriters</li></li></ul><li>
  49. 49.
  50. 50. The Symbiotic Relationship(The Rating Agencies)<br />Primary Agencies <br /><ul><li>Moody’s
  51. 51. S&P
  52. 52. Fitch
  53. 53. Agencies started to rate CRE CDOs 2004</li></li></ul><li>Ratings Agencies <br />Key Rating Parameters<br /><ul><li>Asset correlation
  54. 54. Default Probability
  55. 55. Recovery Rate</li></ul>Pre-Sale Report <br /><ul><li>These reports are meant to outline strengths, concerns, characteristics, etc. of the deal in question before the deal is marketed to potential investors</li></ul>Indenture<br /><ul><li>Deals rated based on the relevant terms of the binding enforceable documents, primarily the Indenture</li></li></ul><li>Ratings Process <br /><ul><li>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. 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. 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. 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.</li></li></ul><li>Commercial Real Estate (CRE ) CDOs<br /><ul><li>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. 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. 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. 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)</li></li></ul><li>
  62. 62. Motivation for Creating a CRE CDO<br />Issuers/Mangers/Sponsors <br /><ul><li>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. 63. Non mark-to-market - No triggers that would require the borrower to post additional collateral. Significant advantage during volatile credit markets
  64. 64. Significant flexibility regarding asset substitution/replenishment
  65. 65. For Asset Mangers it creates portfolio diversity along with increased management fees
  66. 66. Arbitrage – The gap between Collateral and Liability spreads</li></li></ul><li>Motivation for Creating a CRE CDO<br />Investors<br /><ul><li>Offer a way to gain access to an otherwise illiquid market
  67. 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</li></li></ul><li>Evolution of Collateral Composition<br />1999-2003<br /><ul><li>Comprised of REIT debt, CMBS paper or a mix of both
  68. 68. Were exclusively utilized by mortgage REIT and B-piece buyers</li></ul>2003-2009<br /><ul><li>B-Notes - Immediately subordinate to the investment-grade (and securitized) component of a first mortgage loan (Can be multi-tranched)
  69. 69. CMBS
  70. 70. Mezzanine Loans – A loan secured by a pledge of equity in the mortgage borrower. Subordinate to the A-note and B-note
  71. 71. Whole Loans – Unrated and unsecured CMBS asset. Grouped into three types: stabilized, transitional (typically land projects) and developmental
  72. 72. Credit Tenant Lease – A loan backed by the property’s rent payments
  73. 73. Preferred Equity
  74. 74. REIT Debt
  75. 75. Rake Bonds – A junior participation or B-note that is held inside of a REMIC
  76. 76. Synthetics (CDS)</li></ul>Recent CRE CDOs <br /><ul><li>Contain riskier assets such as condominium conversion, land and construction loans which are affected with a downturn in the economy</li></li></ul><li>Sample Old vs New Collateral Composition<br />
  77. 77. Additional Examples of Collateral Evolution <br />
  78. 78. Basic Structure<br />
  79. 79. The Capital Structure<br />
  80. 80. Hypothetical Office Loan Structure<br />
  81. 81. CRE CDO Buyer Base<br />The geographic distribution of CRE CDO is approximately 65% domestic investors and 35% international investors.<br />
  82. 82. CRE CDO vs CMBS<br />CRE CDO spreads have been historically wider than the spreads of CMBS<br />(A triple-A CRE CDO paper can offer 10bp to 30bp pickup over comparable rated CMBS) <br />