GLG Institute Presentation Collateralized Debt Obligations Jim Finkel CEO, Dynamic Credit Partners
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Council Member Biography
Jim Finkel is the co-founder and Chief Executive Officer of Dynamic Credit Partners. Mr. Finkel and his team compile collateralized debt obligation (CDO) packages for investors; specializing in bond portfolios (CBOs) and hedge funds. He is primarily responsible for sourcing investment opportunities, risk management, marketing and compliance. Mr. Finkel has over 20 years experience in the area of structured finance and has transacted in CDOs since 1996. Previously, he was Managing Director of the European CDO team at Deutsche Bank in London. Prior to DB, Mr. Finkel was in the structured products/derivatives group at Bear Stearns in both London and New York (1996-2000). He also has significant mortgage-backed and asset backed experience from his first trading desk position with Nomura Securities in 1992-1994.
Components of a CDO
Developments in the CDO Market
Current Market Dynamics
Asset Class Comparison
First Thing-Let’s Kill all the Journalists “ Sound Credit Tool Or Toxic Waste?” Applied Derivatives, December, 2004 “ A Ticking Time Bomb?” The legacy of the early days of the synthetic collateralized debt obligations market could be a painful future for many of the institutions involved. Risk Magazine , October 2004 “ Are Derivatives Weapons Of Mass Financial Destruction?” Is a Meltdown Cooking in Exotic Assets, Or Can Markets Handle the Next LTCM? …Warren Buffett warned that the global financial system was held hostage to ticking "time bombs" and at risk of a "megacatastrophe.“ Financial Times, May 2006 “ A scandal waiting to happen?” Tuesday, 26 February, 2002, BBC News, referencing CDOs as the next Enron “ The Toxic Avenger” Collateralized debt obligations raise capital for junk-rated borrowers. CFO.com , January, 2002 The Poison in Your Pension “ As the $503 billion-a-year CDO market thrives, CDO marketers like Bear Stearns and Citigroup find buyers for the portions known as toxic waste, the equity tranches.” Bloomberg Markets , July 2007 “ Structured finance CDO—not cash on delivery” Structured finance can bring unstructured losses…. The chairman of American Express, Kenneth Chenault, was man enough to admit last week that his outfit “did not fully comprehend” the risk underlying a portfolio of whizz-bang investments known as CDOs. The Economist , July 2001 “ Barclay’s ‘Toxic Waste’ Row with German Bank Settled” Barclays had settled a high profile dispute with a German bank which was claiming $150m to cover its losses in financial instruments which have been described by regulators as “toxic waste” The Guardian , February, 2005 “ Invest at the Point of Maximum Pessimism” Sir John Templeton Collateral Debt Obligations: Complex and Risky - Yet Popular Financial Times , November 2004
Example of a Typical Cash Flow CDO Structure All in “ cost of funds” 6 % 12% of Capital Structure Yield = 8% ASSETS DEBT LIABILITIES & EQUITY 2 % Excess Spread 88% of Capital Structure MBS (Mortgage-Backed Securities) Bonds Bank Loans Middle Market Loans Emerging Market Debt ABS (Asset-Backed Securities) MBS (Mortgage-Backed Securities) Ongoing Junior Management Fees Arranging Bank Upfront Fees and Ongoing Senior Management Fees Upfront Deal Expenses (Legal/Rating Agency/Accounting) Ongoing Administrative Expenses Equity Tranche 12% Equity = 8x leverage 8x leverage of 2% excess spread = 16% projected IRR Mezzanine Notes : A through BB rated Bearing coupons of LIBOR + 100 - 1100 Senior Notes : Aaa/AAA to AA rated Bearing coupons of LIBOR + 25 - 80
Ramp Up Reinvestment Amortization Closing What Does A CDO Manager Do ? Year 1 Redemption Right at Year 3 Year 4-5 Year 8-10 Auction Call at Year 8-10 Year 12 Final Legal Maturity Stages in the Life of a CDO
Development of the CDO Market HY Credit defaults of 2001/2002 take their toll Evolution of ‘synthetic’ CDOs from the credit default swap markets CDO underlying assets classes converge on more stable, secured assets (leveraged loans, ABS) Market reaches tightest spread levels ever Issuance volume hits record levels Efficiencies via enhanced competition and lower fees 2002 2003 2004 2005 1996 1997 1998 1999 2000 Rating Agencies Issue CDO Criteria 2006 2001 CDO Manager growth, consolidation and personnel shifting Secondary market develops 2007 Shift in issuance away from HY/EM; beginnings of ABS CDOs in US Subprime woes cause market to correct CDO Timeline
Market Snapshot: Volume and Issuance Breakdown Source: JP Morgan May 2007 YTD $ Billion
Growth of ABS CDO Issuance Source: JPMorgan As of 5/14/2007
Source: JPMorgan Leveraged Loan Spreads and CLO Issuance Volume
Euro CLOs currently have lower funding costs and more stable asset spreads than US CLOs.
This translates into higher equity returns
Source: JP Morgan Estimated CLO Equity Returns* US and Euro CLO Equity Returns * Hypothetical returns based on the cost of liabilities and asset spreads. Does not reflect actual returns. IRR %
Alpha Generation through Trading CDOs
Dynamic Credit Partners, LLC
Evolution of Dynamic Credit Partners
each backed by a portfolio of (AAA to A) ABS and CDO debt tranches
each backed by a portfolio of mezzanine CDO debt tranches
opportunistic, value–orientated investments in subordinated debt of CDOs and ABS, as well as proprietary risk-sharing trades
Stockbridge CDO CDO^2 $250mm Closed - November 2004 Lenox CDO Hybrid CDO^2 $255mm Closed - December 2005 Sheffield CDO CLO^2 $307mm Closed - April 2006 Sheffield II CDO* Hybrid CLO^2 $325mm Closed - December 2006 Magnolia 2006-11 CDO $40mm Closed - December 2006 Magnolia 2007-1 CDO $40mm Closed - March 2006 DCOF II $88.99mm Launched - August 2005 Open ESE Funding $75-150mm Launched - December 2005 Open to DCOF II Investors Barrington CDO $1,000mm Closed - December 2005 Monterey CDO $1,002mm Closed - March 2006 Barrington II CDO $1,763mm Closed - May 2007 DCOF I $30.9mm Launched - March 2004 Terminated – December 2005
both referencing a portfolio of BBB rated or higher CDO tranches
Dalton CDO Long/Short ABS CDO^2 $400mm Priced - May 2007 Investment Products CDO^2s HG ABS CDOs Bespoke CDOs Structured Credit Funds *Nominated for 2006 CDO of the Year by US Securitization Awards
Organization - Chart Daniel Nigro Trader/Portfolio Manager Chris Sandleitner ABS Analyst Mendel Starkman Senior CDO Analyst Dov Warman CDO Analyst Deo Sabino CDO Trader/Analyst Aniket Deshpande CDO Analyst David Schwartz, CFA Trader/Portfolio Manager Sam Haddad CDO Analyst CDO Team ABS Team Jim Finkel CEO Tonko Gast CIO Lauren Wright Mark Salama Marketing & Investor Relations General Counsel Edward H. Benton, Esq. Sumeet Sablok ABS/CDO Intern David Goldweitz CMBS Analyst Lily Miao Marketing Intern Eugene Shklyar Generalist Programmer Steve Pennington Quantitative Systems Pamela Byrd Database Development And Programming Systems & Analytics John Gallo Systems Administrator Jing Lu Quantitative Developer Andrew Ragone Programmer Andrew Wax Chief Operating Officer/ Chief Compliance Officer Ashley Montgomery Controller/ Investor Support Karen Llopiz Executive Assistant Administration Andrea Kollmorgen CDO Support Analyst David Lee CDO Surveillance/ Opportunities Fund Support Chris Hughes CDO/ABS Trade Support Operations
DCOF II is a structured credit opportunities fund that primarily invests in subordinated CDO and ABS tranches in the secondary market.
Dynamic specializes in analyzing these complex structured credit securities, where mispricings are more prone to occur.
Dynamic is able to exploit these opportunities through its proprietary analytics, its disciplined approach to measuring risk/ reward, and market access due to deep relationships.
Dynamic expects to generate annual returns for DCOF II in the low to mid-teens while placing paramount importance on the preservation of capital.
2x Maximum leverage; current leverage only 10% of NAV
1-year and 3-year lockup classes, bearing 2/20% and 1/15% fee structures, respectively.
Administrator- Meridian Fund Services (NY & Bermuda)
Prime Broker- Bear Stearns & Co., Inc.
DCOF II – Info and Performance DCOF I (Predecessor Fund) launched in March 2004 and was liquidated December 2005 DCOF I Total Return: 20.4% net IRR since inception Disclaimer: This document does not constitute an offer to sell or buy any securities and may not be relied upon in connection with any offer to sell or buy securities. Any such offer will be made only to qualified investors by means of the Fund’s Confidential Private Placement Memorandum and Subscription Document, which should be reviewed carefully prior to investing. An investment in the Fund is speculative and may involve a high degree of risk. This is not intended for public use or distribution. Past performance is not indicative of future returns . *As the Sharpe Ratio is based on a very small data set, its interpretation as a performance measure requires caution 49 positions of the 56 in the portfolio have an aggregate of approximately 5,500 underlying credits 13.06% Last 12 Month Return $88.99 million AUM as of June 1, 2007 2.68 Annualized Sharpe Ratio* 24.09% Cumulative Return 3.47% Year to Date Return 0.99% Average Monthly Return C Share Class DCOF II Performance Summary