Title: Henry Albulescu Managing Director
1Introduction to SPs CDO Methodology
- Henry AlbulescuManaging Director
- 1-212-438-2382
- henry_albulescu_at_sandp.com
23 Steps To CDO Structure
- Collateral Quality and expected Default Rates
- Recoveries on Defaults Capital Structure
- Legal and Structural Analyses
3Step 1 - Asset Pool Default Rates
- Pool Default Rates Driven by- Asset type (
Corporate vs. ABS)- Rating of each asset-
Exposure to each obligor- Industry of each
obligor- Exposure period (maturity) - SPs CDO EVALUATOR gives Gross Pool Default
rates- Model uses Monte Carlo simulation to
calculate the expected default rate at each
rating level. - - Example AAA 40
- AA 35
- A 30
- For a tranche of a CDO to be rated, it must at
the minimum survive the gross default rate at
that rating level
4CDO Evaluator
- Analyzes Portfolio Credit Quality
- Creates Probability Distribution of Portfolio
Default Rates - Produces the rating Scenario Default Rates needed
for rating a tranche - Key Attributes of CDO Evaluator
- Directly incorporates correlation
- No Industry Notching
- Utilizes Monte-Carlo Methodology
- Used for pools of Corporate, ABS, and Sovereign
debt
5Portfolio Inputs
- List of Assets in the CDO, specifying
- Obligor Identification number
- Industry or ABS Type
- Principal amount
- Issuer Credit rating
- Maturity
- Sovereign Country and Rating, if needed
6Sample Asset Input
7Monte Carlo Methodology
- Precise
- When do enough simulation trials
- Robust
- Need only state the problem
- Can model very complex problems
- Fast
- Todays PCs can do simulations fast
8Example of Simulation Process
9Results of 5 Trail Simulation
10ABS and Corporate Defaults
- Continue modeling Corporate Debt as in the past
with default rates based on rating and maturity - Historical ABS Defaults
- Are much less than corporate defaults
- Are not sensitive to Maturity
- Model ABS Securities as
- With its own default rate and independent of
Maturity
11Implied Asset Default Rates
- AAA AA A BBB
BB B - Corporate
- Year 4 0.19 0.57 0.81 1.81
9.49 21.45 - Year 7 0.52 1.20 1.81 3.94 14.20
26.15 - Year 10 0.99 1.99 3.04 6.08
17.47 28.45 - ABS 0.25 0.50 1.00 2.00
8.00 16.00
12Example of Simple Portfolio
- 50 Diverse 10 year BB Corporate Credits
- Probability of Default for each is 17.47 based
of SPs Corporate default study.
13Portfolio Default Rate Distribution for Simple
Diverse Portfolio
7 probability of 24 default rate
2.1 probability of Default Rate exceeding 28
14Next Step Use the Default Distribution To
Determine Scenario Default Rates
- For example, determine the A Scenario Default
Rate (SDR) such that - The probability of exceeding it is approximately
equal to the probability of a A corporate bond
defaulting. - Based on default table, 10 yr A credit has
3.04 probability of default.
15A Scenario Default Rate
A Corporate Default Probability 3 or
less 28.56 Default rate
16Scenario Default Rate
- Based on the simulation, under the A
probability of default is 3.04, the asset pool
would experience no more than 28.56 default
rate. - To rate the CDO tranche A it must them be able
to withstand 28.56 Gross defaults of the asset
pool. - If so, such a tranche should be rated A
17CDO Tranche Default Probabilities
Sized for the corporate default tables
AAA AA A BBB BB
B Corporate Year 4 0.19 0.57
0.81 1.81 9.49 21.45 Year 7
0.52 1.20 1.81 3.94 14.20 26.15
Year 10 0.99 1.99 3.04 6.08 17.47
28.45
18Scenario Default Ratesfor Simple Portfolio
AAA 36.00 AA 33.30 A 28.56 BBB 24.18
BBB
A
AA
AAA
19ASSUMPTIONS
- Rating of Asset implies its probability of
default. - Underlying each Asset is a pool of collateral or
an obligor whose behavior is correlated.
20Sector Correlation Assumption
- ABS
- 0.3 within ABS sectors (e.g. CMBS vs. CMBS)
- 0.1 between ABS sectors (e.g. CMBS vs. credit
cards) - Corporates
- 0.3 within Industry sectors (e.g. auto vs. auto)
- 0.0 between Industry sectors (e.g. auto vs.
utilities)
21AA
AA
22Step 2 - Synthetic Recoveries
- Absent recoveries and excess spread, each tranche
would need the level of support equal to the
gross default rate expected at that rating level. - Recoveries on Cash Settled synthetics are driven
by- Mid Point of managed recovery range- Time
to settlement- of bids and bid taken-
Cheapest to deliver convertibility option-
Specified currency- Credit event if old
restructuring is used
23Synthetic CDO
Eligible Investments
Assets
cash
Class A Class B Class C Equity
Sponsor/ Protection Buyer
SPV
fee
notes
contingent payment
cash
Reference portfolio
24Example of Synthetic Recovery
- Mid Point of managed recovery range 37.00
- Cheapest to deliver 2.5 less -
1.85 - Convertibility option 2.5 less - 0.93
- Specified currency 2.5 less - 0.93
- Time to settlement 50 less - 18.5
- Effective recovery rate 14.8
25Synthetic Capital Structure
- Evaluator Scenario Default Rates (SDRs)
- AAA Default Rate 40
- BBB Default Rate 20
- Recovery rate
- 25, thus loss is 75 of defaults Losses on
each rating - AAA 40 defaults 75 loss 30 BBB
20 defaults 75 loss 15 - Capital Structure (Tranche size) is
- AAA 70 BBB
15 Equity (NR) 15
26Cash Flow CDO Structure
Market / Sponsor
SPV
Loan/Bond Portfolio
Class A Class B Class C Equity
notes
cash
cash
27Cash Flow Recoveries Based On Assets
- Recoveries on physical debt instruments held by
the SPV are driven by - - Insolvency regime- Seniority and security-
Historical recovery date- Manner of realizing
recovery- Abilities of Manager
28Cash Flow CDO Recovery Levels
- Not A Function Of Asset Ratings Or Notes
- Driven By The Seniority Security Of The
Obligations - Influenced By The Actions Of The Collateral
Manager
US Recovery Ranges
Bonds () Loans ()
Senior Secured 40 - 55 50 - 60 Senior
Unsecured 25 - 44 25 - 50 Subordinated 15 -
28 15 - 28
29Cash Flow Deal Capital Structure
Proposed Capital Structure Is Analyzed by
Modeling
- Default Rate
- Default Timing
- Default Patterns
- Recovery Timing
- Recovery Levels
- Interest Rate Curves
- Hedge Structures
- Asset Characteristics
- O/C I/C testes
Class size at each rating level
Transaction Cash Flow Model
30Multiple Scenarios In Cash Flows
Fence in as many variables as possible
- 1 Default Rate per Rating
- x 5 Default Timings
- x 5 Default Patterns
- x 5 Interest Rate Curves
- 125 Cash Flow Runs Per Rated Class
31Sample Results Form Cash Flows
- 5 Loans in Asset Pool - 42.4 Default rate
needed for AAA - Maximum Default Rate
-
- Default Curve 1 Default Curve 2
Default Curve 3 Default
Curve 4 Yr 2 Yr 6 Yr 2 Yr 6 Yr 2 Yr 6 Yr
2 Yr 6 - LIBOR up 62.0 56.5 64.5 58.0 64.0 57.0 61.0
55.5 - LIBOR Dn 58.5 57.5 59.5 55.5 60.0 57.5 59.0
58.5 - Swap Rate 53.5 50.5 53.5 49.0 54.5 49.5 54.5
51.0 - Cap Rate 53.5 50.5 53.5 49.0 54.5 49.5 54.5
51.0 - Constant 54.0 51.0 54.0 49.5 55.0 50.0 54.5
51.5 - Up-1 62.5 61.5 65.5 59.0 63.5 62.5 61.0 62
.0 - Up-2 60.5 49.0 61.5 47.0 61.5 49.0 58.5 50
.5 - Down-3 56.0 55.0 56.5 53.5 57.0 54.0 56.5 5
5.5
32Last, but Not Least
- Legal Analyses - Transfer of Assets
- - SPV Separation
- - Governing Law
- - Transaction Documents
- - Rights of Noteholders
-
33Additional Information
- Global Cash Flow and Synthetic CDO Criteria
March 2002 - Criteria for rating Synthetic CDO Transactions
Oct. 2003 - Both publications available on
- SPs RatingsDirect,
- www. standardandpoors.com
34Request Information or CDO Evaluator at
- Local SP Office
- or
- CDOevaluator_at_SandP.com
35(No Transcript)