This document provides an overview of collateralized debt obligations (CDOs) focused on commercial real estate. It discusses the taxonomy and anatomy of CDOs, including the types of assets they contain, their capital structure, and the parties involved such as issuers, investors, and rating agencies. It also describes the evolution of CDO collateral over time from assets like REIT debt and CMBS to include riskier products like whole loans, B-notes, and mezzanine loans.

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 StreamsREIT 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 profitsTaxonomy 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 marketTaxonomy 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 AssetsTaxonomy Based on RegionWhere do the assets come from?U.S. High Yield CDOs

33. European CDOs

34. Emerging Market CDOs

35. Asian CDOs

36. Japanese CDOs

37. Korean CDOs

38. Etc.The Lifecycle of CDOs

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

50. The Symbiotic Relationship(The Rating Agencies)Primary Agencies Moody’s

51. S&P

52. Fitch

53. Agencies started to rate CRE CDOs 2004Ratings Agencies Key Rating ParametersAsset correlation

54. Default Probability

55. Recovery RatePre-Sale Report These reports are meant to outline strengths, concerns, characteristics, etc. of the deal in question before the deal is marketed to potential investorsIndentureDeals rated based on the relevant terms of the binding enforceable documents, primarily the IndentureRatings 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 ) CDOsA 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 CDOIssuers/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 spreadsMotivation for Creating a CRE CDOInvestorsOffer 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 trancheEvolution of Collateral Composition1999-2003Comprised of REIT debt, CMBS paper or a mix of both

68. Were exclusively utilized by mortgage REIT and B-piece buyers2003-2009B-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 economySample 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 BaseThe geographic distribution of CRE CDO is approximately 65% domestic investors and 35% international investors.

82. CRE CDO vs CMBSCRE 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)