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CDO: Collateralized Debt Obligation

The New Choice in Global Reinsurance. CDO: Collateralized Debt Obligation. Contents. Why CDOs? What is a CDO Examples and Types of CDOs Advantages & Disadvantages New Solutions Approach Conclusion. Why Consider CDOs?. Fastest Growing Sector of the Asset Backed Securities Market (ABS)

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CDO: Collateralized Debt Obligation

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  1. The New Choice in Global Reinsurance CDO: Collateralized Debt Obligation

  2. Contents • Why CDOs? • What is a CDO • Examples and Types of CDOs • Advantages & Disadvantages • New Solutions Approach • Conclusion

  3. Why Consider CDOs? • Fastest Growing Sector of the Asset Backed Securities Market (ABS) • 2nd Largest ABS after Credit Card Receivables • Global Issuance over the Last 3 Years: $137 billion per year

  4. Growth in CDO Volume

  5. Debt Securitization Pool of Diversified Debt Obligations is Packaged and Sold to the Capital Markets The CDO Issues Multiple Layers/Tranches of Securities: Senior, Mezzanine, Equity (First Loss) Payments to CDO Tranches depend on the performance of the Underlying Portfolio of Assets Underlying Portfolio can be - Real or Synthetic; Actively Managed or Passive What is a CDO?

  6. Generic CDO Structure Senior Fixed or Floating Rate Notes Collateral Manager Diversified Pool of Underlying Assets (Collateral) CDO Special Purpose Vehicle (SPV) Mezzanine Fixed or Floating Rate Notes Subordinated Notes Equity

  7. Example of CDO Tranching AAA 370M A High Yield CLO arranged by Bear Sterns. (Eaton Vance) AA 49M BBB 47M BB 5M Equity 40M

  8. Example of CDO Tranching CDO arranged by Bear Sterns where underlying collateral is investment grade. (Meliorbanca Parthenon I) “Super Senior” 912.5M AAA 15M AA 4% AA 22.5M A 10M BBB57% A 39% BBB 15M BB 5M Equity 20M Equity to AAA 87.5M

  9. Types of CDOs • Arbitrage & Off-Balance Sheet • Arbitrage CDO Weighted Average Coupon of Underlying Securities > Weighted Average Coupon of Repackaged Securities • Off-Balance Sheet CDO Financial Institutions can achieve Capital Relief by securitizing balance sheet assets

  10. Types of CDO Collateral CDOs Have Been Issued For: • Commercial Loans • Corporate Bonds • ABS • Mortgage Backed Securities • Emerging Market Debt • CDOs of CDOs

  11. Who Buys CDOs? • Insurance Companies • Institutional Investors

  12. CDO Advantages • Different Tranches allow Investors to customize their Credit Risk exposure • Efficient Mechanism for taking Diversified Credit Exposure • Attractive Spreads relative to similarly rated Assets

  13. CDO vs. Bond Spreads (to the Swap Curve)

  14. CDO Downsides • Pricing is based on Rating Agency assigned default probabilities – which may not reflect True Underlying Risk • Expenses – Origination & Management Fees reduce the economics to Investors

  15. Market Yields on Identically Rated Bonds • Yields for identically rated securities can vary widely • This implies that the Market’s assessment of default probabilities is not uniform across a particular rating category • Both the bonds below are rated A2 by Moody’s:

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