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Collateralized Debt Obligations

(CDOs) – Part 1 off 2
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โครงการอบรม
Financial Management of Structured Products
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โดยสมาคมนักวิเคราะหหลักทรัพย สมาคมตลาดตราสารหนไทย
โดยสมาคมนกวเคราะหหลกทรพย สมาคมตลาดตราสารหนี้ไทย และ สํสานกบรหารหนสาธารณะ
านักบริหารหนี้สาธารณะ กระทรวงการคลง
กระทรวงการคลัง
Bangkok Convention Centre at CentralWorld
September 27, 2007

Sombat Jiwariyavej
Product Development, Treasury Group, Siam Commercial Bank
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Important Note:

This presentation is prepared for information and discussion purposes only. It does not represent or
.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.
3 Credit Derivatives
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• Definition
• Credit Default Swap: A Building Block
of Synthetic CDO
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• IS
ISDAA Credit Derivatives
erivatives Definition
efinition
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
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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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“I
“Integral
l to the
h process off Securitization
S ii i i the
is h concept off "True
"T S l " It
Sale". I is
i
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 post-
sale. Securitization is an institutionalization of this aim.”

Source: Wikipedia.org
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Introduction to Securitization
Securitization Flow Diagram
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DHR / TA/
SPV does not engage in any business
activities other than owningg receivables
CA
and issuing bonds to comply to SEC. It
cannot have employee. Therefore, it
hires professional 3rd parties to run the
securitisation transaction
Sales of Credit Card
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Receivables
Cash
Seller/ SPV Debenture
Originator Seller Loan (Bond Issuer) Holders
Sub Loan
Transfer notification to
cardholders is exempted. Bond Proceed
Cardholders can use the credit
Purchase of credit card receivables are settled into 3 pieces
ยerform servicing function
.or

cards and make payment to KTC - Cash settlement (equal to Rated Bonds proceeds)
a s u s u a l. for SPV - Seller Loan, ranking pari passu to Rated Bonds
- Sub Loan, serving as Credit Enhancement by
subordinating right to receive principal and interest after
Installments Rated Bond and Seller Loan
Obligors Servicer

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 Introduction to Securitization
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Sample of ABS Waterfall
Holders of Rated Bonds and
Seller Loan always receive cash

Collecttion
flows from credit card receivables
prior to Sub Loan holders
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Internal Enhancem

AAA (ST) AAA (LT) Seller Loan

AA Can be structured by:
• Time tranching to fit investor
A investment horizon
Sub loan • Credit tranching to suit
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Sub Loan absorbs first loss investor risk/return appitite
ment

f
from credit
dit card
dddefault
f lt via:
i • Bullet and amoritzing for
• Cash flows waterfall structural efficiency
• Interest calculation on
notional principal Relative size depend on
• Sub Loan write-down on - expected loss
Loss

receivable default - targeted ratings

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Introduction to Securitization
Sample of ABS Repayment Profile
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Seller Loan mitigates co-creditors risk

Outstanding (all receivables from the same
cardholder must be sold to SPV)

Liability
Li bilit can be
b extended
t d d longer
l than
th
asset life by “Revolving” mechanism
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AAA (ST)
Same rating but different
tenors (time tranching)

AAA (LT)
Same tenor but different
AA ratings (credit tranching)
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Sub Loan

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 Introduction to Securitization
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Benefits of Securitization

Diversify Reduce
Source of Fund Cost of Fund
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• New funding platform in • Can be enhanced to achieve
addition to corporate bond higher rating than
and BE Seller/Originator corporate
rating

Securitization • Debenture tenor flexibility

(time tranching)
• SPV Rated Bonds is not • Debenture amortizing profile
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consolidated to flexibility
Originator/Seller • Self-finance redemption

Off-balance Debt Profile

Sheet Management
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Introduction to Securitization
Samples of Securitized Assets
Any current or future cash flow that is generated by assets can be securitized. The most
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common types of asset include:

Aircraft
Automobile Lease Bond
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Loan/Purchase
Credit Card
Receivable

Bank
.or

Loan

Residential/Commercial Equipment
Mortgage Lease 10
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 Introduction to Securitization
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Categorization by Asset Types

ABS CDO
Synthetic
y CDOs
Cash
C h CDO
CDOs off
(not necessarily
Bank Loans,
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Credit Cards, considered
Bonds,
Auto Loans, SME Loans,
Securitization)
Future Flows, Corp Credit.
Trade Receivables,
etc. MBS
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SSubprime
b i (B&C) M
Mortgages,
t
Home Equity Loans,
HELOC, etc 1st Mortgage (A, Alt-A, Jumbo)
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.
portfolio The term CDO is often used as a generic term that includes:
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• 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.
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• CDO^n
CDO n -- Generic term for CDO^3
CDO 3 (CDO cubed) and higher,
higher where the CDO is backed by other
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
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Introduction to CDOs
Categorization of CDOs
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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
Balance Sheet CDOs are Arbitrage CDOs are
structured for Seller’s structured to arbitrage
credit risk management Purpose higher yield assets and
and regulatory capital diversification benefit
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purpose. over the CDO issuances.

Cash CDOs use funding
Synthetic CDOs gain
from CDO Notes issuance
credit exposure by
to purchase physical Funding entering into Credit
assets ee.g.
assets, g bonds or D f lt SSwap contract.
Default t t
loans.
.or

Cashflow CDOs intend to Money Market CDOs

repay CDO Notes by intend to make gain from
using interest and Manageability actively trading on
principal repayments changes in market value
from assets. 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
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Asset 1
Asset 2
Asset 3 SPV Class B
:
: :
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Asset N :

Hedge Provider Equity

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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
h transfer
f off the
h underlying
d l asset. This
h is usually
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achieved by transferring risk on a credit reference asset. It
is designed to allow independent trading and hedging of
credit risk.
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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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Credit Derivatives

Advantages of Credit Derivatives

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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
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• 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
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• Simplify “Relative Value Trading” in credit market

• Document with Standardized ISDA Template
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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 Reference Entity
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not against changes
g in credit
quality (i.e. credit spread) of
the reference entity. Reference
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Protection Buyer CDS Premium Protection Seller

Credit Event occurs

Physical
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Settlement
B
Buyer deliver
d li defaulted
d f lt d bond
b d

Seller pays full notional amount

Or Cash
Settlement Seller pays loss amount
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Credit Derivatives

ISDA Credit Derivatives Definition

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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.
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• Provides base template for credit derivative instruments

• Defines types of “Credit Event” on reference entity
• Defines Obligation Categories and Characteristics for
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purposes of Credit Events and settlement

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 Credit Derivatives
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5-year USD CDS Premium
120
ATC PTT
KOT TOP 100

Basis Points per annum

m
PTTCH
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80

60

40
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20

0
Dec-06
Aug-06

Oct-06

Aug-07
Apr-07
Sep-06

Nov-06

Jan-07
Feb-07

Sep-07
May-07
Jun-07
Mar-07

Jul-07
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Credit Derivatives

Credit-Linked Notes: An Application of CDS

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T+Credit Spread
Bondholder Bond Issuer
Liquidation
Li id ti Proceed
P d
Reference on
Defaulted Bond Credit Event
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CDS
Reference on Defaulted Bond Counterparty
Price as Recovery Rate
CDS Loss
Premium =(1-Recovery)
T +CDS
CDS P
Premium
i
B/E Holder B/E Issuer
.or

Recovery
T
In theory, cash bond can be replicated
using Credit-Linked Note Structure,
Risk-Free Bond
and assume away all counterparty B/E
issuer risks
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CDO Structures
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CDO Structures

(Funded) Synthetic Balance Sheet CDOs

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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
Proceed
CLO Originator

CLO Investor Issuer

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CDS CDS
Premium Premium
Reference
Bonds/Loans
Junior Risk-Free Portfolio
RF Rate Asset
CLO Investor Reference
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Credit Event occurs

Issuer pays
Cash recovery Issuer pays
Settlement amount Loss amount

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 CDO Structures
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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.
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CDO Portfolio CDS
Issuer Counterparty
CDS
Proceed Premium
Mezzanie Reference

CDS
Premium Risk-Free Reference
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Asset Portfolio
RF Rate

Credit Event occurs

Issuer pays
Cash recovery Issuer pays
Settlement amount Loss amount
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CDO Structures

Payments Flow in Synthetic CDOs

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Premium SPV Coupon

Credit Credit
Protection Protection
Credit Default
Buyer Swap Notes Seller
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Proceeds
Credit Event
Payments Principal
Repayment
ate
RF Ra

Example of
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Reference a funded
Pool synthetic CDO
Collateral

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 CDO Structures
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(Unfunded) Synthetic CDOs

Premium
Credit Credit
Protection Protection
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Buyer Credit Default Seller
Swap

Credit Event
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Payments

Reference
Pool
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CDO Structures

A Sample Single Tranche CDO (STCDO)

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Reference Pool CDO Liability

Ref. Entity 1
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Ref. Entity 2 Virtual Tranche

Ref. Entity 3
“Detachment
:
Point”
: Loss
Target
Loss
Ref. Entity
yN
T Lossh
Tranche
“Attachment
Loss
Virtual Tranche
.or

Loss Point”
Loss

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 CDO Structures
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CDO-Squared: a More Complex Correlation Intensive Structure

CDO^2
Target Tranche
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1st Level
“Virtual”
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CDOs

Reference Pool
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LOSSES
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CDO Structures
Another Common CDO^2 Structure
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~20%-30%
20% 30% Par g Tranche
Target ~70%-80%
70% 80% Par
~100% Risk ~0% Risk
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~A-Aa tranches

Aaa ABS Reference Pool

.or

Reference Pool

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 CDO Structures
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ABSCDO repackages RMBS enabling further arbitrage (leverage)

Mtg 1
RMBS Class A
Mtg 2
Mtg
Mt 3
SPV RMBS Class B
: :
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: :
Mtg N Subordinate RMBS Cl.B
Mtg 1
RMBS Cl.B SPV
RMBS Class A RMBS Cl.B
Mtg 2 : CDO Mezz
Mtg 3 :
SPV RMBS Class B
: RMBS Cl.B
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: :
: :
Mtg N Subordinate :
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CDO Structures
Cash versus Synthetic CDOs
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Key Differences between Cashflow and Synthetic CDOs

• Assets Pool
• True Sales
• CDS vs cash assets: Credit Events, WAL
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• Ramp-up period
• Transaction Structure
• OC/IC Triggers
• Reinvestment Period
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• Collateral Assets in Synthetic CDOs

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 CDO Structures
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Hybrid CDO
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Source: Fitch
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CDO Structures
Hybrid Cash + Synthetic CDOs
Key Characteristics:
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• Asset pool consists of both synthetic (mostly referencing RMBS) and cash
(predominantly ABS) assets. To date, the mix has been around 60-80%
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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.
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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,
revolver and
later expected repayment from cash assets.
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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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www.scb.co.th
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Contact
Sombat Jiwariyavej, +66.2544.2178, sombat.jiwariyavej@scb.co.th
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