prof. ian giddy new york university structured finance: synthetic abs
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Copyright ©2002 Ian H. Giddy Structured Finance 2
Structured Finance
Asset-backed securitization Corporate financial
restructuring Structured financing
techniques
Copyright ©2002 Ian H. Giddy Structured Finance 3
Collateralized Debt Obligations
Collateralized loan obligations (CLOs) Collateralized bond obligations (CBOs)
Copyright ©2002 Ian H. Giddy Structured Finance 4
Collateralized Debt Obligations
Cash flow backed CLOs and CBOs Market value backed CBOs Synthetic CLOs
Copyright ©2002 Ian H. Giddy Structured Finance 5
Cash Flow Backed CLOs
BANK (SELLER)
SPECIALPURPOSEVEHICLE
LOANS
ISSUESASSET-BACKEDCERTIFICATES
SALE ORASSIGNMENT
LOANS
Motivations:
Free up capital
Lower cost of funding
Distressed loan arbitrage (3rd party sponsors)
Motivations:
Free up capital
Lower cost of funding
Distressed loan arbitrage (3rd party sponsors)
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CLO Rating Criteria
Initial ReviewOriginator’s credit evaluation systemPool composition & stress testing
On-Site Due Diligence Legal Integrity
Bankruptcy-remoteness of SPVValidity of asset transfer to SPVPerfection of security interests in underlying
collateral
Determining Credit Enhancement
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Cash flow Backed CLOs
CREDIT
ENHANCEMENT
SPVLOANS Investors
Senior-Sub with priorities of cash flows
Cash reserve accounts Letters of credit Guarantees
Cash
flows
ABS
flows
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Cash Flow Backed CBOs
SPECIALPURPOSEVEHICLE
ISSUESASSET-BACKEDCERTIFICATES
SALE
BONDPORTFOLIO
BONDS MANAGER
Motivation:
Cash flow arbitrage (bonds have good returns relative to risk, but may be illiquid)
Motivation:
Cash flow arbitrage (bonds have good returns relative to risk, but may be illiquid)
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Cash Flow Backed CBOs
Cash flow CBOs are built around a pool of assets with predictable cash flows. As such, these structures are restricted to investments that meet minimum credit quality, tenor and expected recovery characteristics. The analysis of a cash flow deal and determination of credit enhancement is based on the expected probability of default, severity of loss, and timing of default and recovery of the assets in the pool.
The ongoing market price of collateral assets is not important in a cash flow deal. Instead, it is the ability of each asset to pay scheduled principal and interest that makes these deals successful.
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Cash Flow Backed CBOs
MANAGER
SPVBONDS Investors
Collateral cash flows meet ABS interest & principal needs
Cash
flows
ABS
flows
Selects portfolio
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Market Value Backed CBOs
SPECIALPURPOSEVEHICLE
ISSUESASSET-BACKEDCERTIFICATES
SALE
BONDPORTFOLIO
BONDS MANAGER
Motivation:
Price arbitrage (bonds are underpriced, and tradeable)
Motivation:
Price arbitrage (bonds are underpriced, and tradeable)
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Market Value CBOs
A market value CBO can be generally described as an investment vehicle that capitalizes on the arbitrage opportunities that exist between high yielding investments and the lower cost funds of highly rated debt. The transaction is typically capitalized with multiple classes of rated debt and a layer of unrated equity and invests in a pool of investments that is diverse in obligor, industry, and, frequently, asset class. In order to gauge the performance of the transaction, the asset manager will mark the value of each investment to market on a regular basis, usually weekly or biweekly.
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Market Value Backed CBOs
MANAGER
SPVBONDS Investors
Trades bonds to meet interest & principal needs
Cash
flows
ABS
flows
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Characteristics of Market Value CBOs
Market value transactions are often collateralized by leveraged loans, high-yield bonds, mezzanine debt, distressed debt, and public and even private equity.
Market value transactions are less restrictive with respect to cash flow requirements, credit quality, and maturity of the collateral.
The manager can trade the securities.
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Rating Agencies Analyze Price Volatility to Determine CE Requirements
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Advance rates determine how much rated debt can be issued against the market value of an asset.
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Example of Market Value CBO Asset Mix and Financing
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Asset-Backed Securities:The Typical Structure
FORD (SPONSOR)
SPECIALPURPOSEVEHICLE
LOANS.
ISSUESASSET-BACKEDCERTIFICATES
SALE ORASSIGNMENT
LOANS.
Servicing Agreement
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The Alternative: Synthetic ABS
DB (Originator)
SPECIALPURPOSEVEHICLE
REFERENCE
POOL OF LOANS
(Stay on
balance sheet)
ISSUESASSET-BACKEDCERTIFICATES
CREDIT SWAPAGREEMENT
TOP QUALITYINVESTMENTS
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Synthetic ABS or Collateralized Loan Notes
CLNs are SPV debt backed by the credit of the selling bank (or better)
No loans are sold to the SPV But performance is based on the
performance of a reference pool of loansIf the reference credits perform, full debt
service is made on the CLNIf the reference credits default, the CLN is
deemed “defaulted”and payment is halted.
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Synthetic ABS
GERMAN BANK (Originator)
SPECIALPURPOSEVEHICLE
ISSUESASSET-BACKEDCERTIFICATES
REFERENCE
POOL OF LOANS
(Stay on
Balance Sheet)
TOP QUALITY
INVESTMENTS
CREDIT
SWAP
AGREEMENT
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Synthetic ABS
GERMAN BANK (Originator)
SPECIALPURPOSEVEHICLE
ISSUESASSET-BACKEDCERTIFICATES
REFERENCE
POOL OF LOANS
(Stay on
Balance Sheet)
TOP QUALITY
INVESTMENTS
EURIBOR
plus
“PREMIUM”
PROTECTION against
POOL DEFAULTS
Copyright ©2002 Ian H. Giddy Structured Finance 26
Credit Swaps in Synthetics: Doubts
Problems with the collateralDebates about “events of default”Workouts and other pre-default losses
Problems with the sponsor bankObtaining title to the collateralThose “high quality investments”
And all those swaps
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Typical Credit Default Swap Arrangement
The guarantee: Pledge of a deposit in the sponsor bank Part or all of that deposit will be forfeited if there are pool losses “Losses in the transaction are defined as amounts
written off in compliance with the bank’s usual procedures”
BANKSPV
ABSREFERENCE
POOL OF LOANSDeposit and
credit guarantee
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Case Study: Global High Yield Bond Trust
What is the legal structure of this deal? What are the assets? What are the different classes of
securities, and their terms? How do the synthetic CLOs work?
(Draw a diagram) Should investors buy the subordinated
tranche?