cdo market primer by kensington blake capital
DESCRIPTION
Attached is a good market primer on the Collateralized Debt Market (CDOs). We prepared this back in 2009 but the data is still good for use today.TRANSCRIPT
Confidential KENSINGTON BLAKE CAPITAL
Kensington Blake Capital, LLCCDO Overview
April 2009
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Important Notice
This presentation (the “Presentation”) is being furnished on a confidential basis to a limited number of sophisticated investors on a “one-on-one” basis for informational and discussion purposes only and does not constitute an offer to sell or a solicitation of an offer to purchase any security. The information set forth herein does not purport to be complete and is subject to change.
The information contained herein does not purport to contain all of the information that may be required to evaluate any securities or other opportunities and any recipient hereof is encouraged and should conduct its own independent analysis of the data referred to herein. Kensington Blake Capital, LLC (“KBC”) and its affiliates disclaim any and all liability as to the information set forth herein or omissions here from, including, without limitation any express or implied representation or warranty with respect to such information.
Certain information contained herein (including targets, forward-looking statements, economic and market information) has been obtained from published sources and/or prepared by third parties and in certain cases has not been updated through the date hereof. While such sources are believed to be reliable, none of KBC or any of their respective affiliates or employees assume any responsibility for the accuracy or completeness of such information.
Each party should seek advice based on its particular circumstances from an independent tax advisor. The use of this Presentation in certain jurisdictions may be restricted by law. The products mentioned in this document may not be eligible for sale in some states or countries, nor suitable for all types of investors; their value and the income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates, or other factors. All parties should inform themselves as to the legal requirements and tax consequences of an investment in the products mentioned herein within the countries of their citizenship, residence, domicile and place of business.
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Certain information contained in this report constitutes “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “seek,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue” or “believe” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance may differ materially from those reflected or contemplated in such forward-looking statements.
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CDO Overview
Description of Collateralized Debt Obligations (“CDOs”):
CDOs are special purpose entities that issue debt and equity backed by a variety of asset classes including the following:
• Investment Grade or High Yield Bonds (CBOs);
• Senior Secured Leveraged Loans (CLOs);
• Emerging Market Debt (EM CBOs);
• RMBS (ABS CDOs);
• CDOs (CDO^2s);
• Bank Trust Preferred Securities (TRUPs);
• Credit Default Swaps referencing corporate debt or structured securities (CSOs); or
• Market Value CDOs (MV CDOs) where the underlying assets could include High Yield Bonds, Leveraged Loans, Mezzanine Debt, or Special Situation investments.
Most CDOs are actively managed by a portfolio manager specializing in one or a multiple of asset classes above.
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CDO Structure
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A portfolio manager is responsible for selecting and monitoring the underlying collateral in CDOs (i.e., leverage loans) for the life of the transaction (i.e., 12-15 years in CLOs).
The portfolio composition is subject to restrictions (minimum diversity requirements, maximum industry exposure, maximum issuer concentrations, rating quality, etc).
The transaction may be called by a majority of equity (the “Preference Shares”) holders, subject to certain restrictions.
The interest earned on the underlying collateral is used first to pay the coupons due to the Notes with the residual interest paid to the Equity.
Principal proceeds are reinvested for the first 5 years and then used to pay down the Notes in order of seniority.
Performance triggers (Overcollateralization and Interest Coverage tests) if breached will divert interest and principal from the subordinated tranches to pay down the senior notes until the triggers pass.
In an Event of Default (i.e., Overcollateralization ratio on senior notes falls below 100%) the collateral may be liquidated subject to certain criteria (i.e., proceeds must be sufficient repay all the Notes in full).
Junior
(Mezzanine)
Notes
Junior
(Mezzanine)
Notes
High Yield Bonds
High Yield Bonds
Senior NotesSenior NotesLeveraged
LoansLeveraged
Loans
Investment Grade Bonds
Investment Grade Bonds
Structured Products
Structured Products
or
or
or
CDO
Underlying Collateral Cash Flows
Investment Proceeds
Preference
Shares
Preference
Shares
Principal +
Coupon
Proceeds
Excess
Cash Flows
Underlying Collateral Securities
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Growth of CDO Market
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Source: Citigroup Research (*Projected)Securities Industry and Financial Markets Association, Global CDO Market Issuance Data
CDO Market Overview The CDO market has grown dramatically over the last few years fueled by a benign credit environment and the search for
yield in an alternative asset class.
In earlier years, the CDO market was dominated by CBOs and CLOs.
Beginning in 2001, CBO transactions performed poorly due to weak structures and high yield bond default rates exceeding 12% (transactions assumed default rates of 2-3% per annum) and low recovery rates averaging 10-20% (transactions assumed 30-40%). As a result, many transactions were downgraded and CBOs are no longer a major asset class.
During this same period, CLOs performed much better when default rates on leveraged loans peaked at 8% due to active portfolio management and high recovery rates on leveraged loans (70-80%). Few transaction were ever downgraded.
The majority of the issuance in 2006/7 was dominated by ABS CDOs.
There is a tremendous amount of distress in ABS CDOs due to poor performance of the underlying RMBS.
CDO Issuance Volume 2000-2007 ($’s in Billions)
$400
$318
$188
$109
$54$53$54$68
$-
$100
$200
$300
$400
2000 2001 2002 2003 2004 2005 2006 2007
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Growth of CDO Market
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Source: Morgan Stanley
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Growth of CDO Market
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Growth of CDO Market
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Growth of CDO Market
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Growth of CDO Market
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CDO Performance
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CLO Spreads
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ABS CDO Structure
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Representative ABS CDO Structure
In the above example, this transaction is defined as a Mezzanine ABS CDO (the average rating of the underlying RMBS securities is BBB). In a High Grade ABS CDO the average rating of the underlying RMBS securities is AA.
The transaction may include as many as 150 different securities including other ABS CDOs selected by a portfolio manager.
Reinvestment Period is 3-5 years with a legal final of up to 35 years.
The transaction may be called by the equity holders, subject to restrictions and may be subject to a mandatory auction beginning in year 8.
If performance triggers are breached interest and principal are diverted from the BBB’s and equity to pay down the senior notes.
In an Event of Default, the transaction may be liquidated or may become static (minimal trading allowed).
Representative ABS CDO Structure*
Source: Deutsche Bank
Tranche Thickness Loss Support Tranche Thickness Loss SupportAAA 80% 20% AAA 80% 20%AA 5% 15% AA 5% 15%A 6% 9% BBB 6% 9%BBB+ 2% 7% O/C (Equity) 2% 7%BBB 1% 6%BBB- 1% 5%
BB 1% 4%O/C (Equity) 4% 0%
* There are many kinds of CDOs; approximately 54% of CDOs issued since2000 are largely backed by subprime RMBS.
Subprime Mortgage Backed Security Trust Structure
~100 subprime RMBS,mostly rated BBB or BBB-
CDO3…
ABS CDO Collateral Pool"Diversified" pool of
ABS CDO Capital Structure
CDO2
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ABS CDO Performance
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