CDO: Collateralized Debt Obligation

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CDO Collateralized Debt Obligation

• The New Choice in Global Reinsurance

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Contents

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

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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

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Growth in CDO Volume
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What is a CDO?

• 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

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

• Arbitrage Off-Balance Sheet
• Arbitrage CDO
• Weighted Average Coupon of Underlying Securities
  gt Weighted Average Coupon of Repackaged
  Securities
• Off-Balance Sheet CDO
• Financial Institutions can achieve Capital Relief
  by securitizing balance sheet assets

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Types of CDO Collateral

• CDOs Have Been Issued For
• Commercial Loans
• Corporate Bonds
• ABS
• Mortgage Backed Securities
• Emerging Market Debt
• CDOs of CDOs

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Who Buys CDOs?

• Insurance Companies
• Institutional Investors

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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

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CDO vs. Bond Spreads (to the Swap Curve)
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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

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Market Yields on Identically Rated Bonds

• Yields for identically rated securities can vary
  widely
• This implies that the Markets assessment of
  default probabilities is not uniform across a
  particular rating category
• Both the bonds below are rated A2 by Moodys