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Henry Albulescu Managing Director

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S&P's CDO EVALUATOR gives Gross Pool Default rates ... O/C & I/C testes. Proposed Capital Structure Is Analyzed by Modeling. Transaction. Cash Flow Model ... – PowerPoint PPT presentation

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Title: Henry Albulescu Managing Director


1
Introduction to SPs CDO Methodology
  • Henry AlbulescuManaging Director
  • 1-212-438-2382
  • henry_albulescu_at_sandp.com

2
3 Steps To CDO Structure
  • Collateral Quality and expected Default Rates
  • Recoveries on Defaults Capital Structure
  • Legal and Structural Analyses

3
Step 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

4
CDO 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

5
Portfolio 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

6
Sample Asset Input
7
Monte 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

8
Example of Simulation Process
9
Results of 5 Trail Simulation
10
ABS 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

11
Implied 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

12
Example of Simple Portfolio
  • 50 Diverse 10 year BB Corporate Credits
  • Probability of Default for each is 17.47 based
    of SPs Corporate default study.

13
Portfolio Default Rate Distribution for Simple
Diverse Portfolio
7 probability of 24 default rate
2.1 probability of Default Rate exceeding 28
14
Next 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.

15
A Scenario Default Rate

A Corporate Default Probability 3 or
less 28.56 Default rate
16
Scenario 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

17
CDO 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
18
Scenario Default Ratesfor Simple Portfolio
AAA 36.00 AA 33.30 A 28.56 BBB 24.18
BBB
A
AA
AAA
19
ASSUMPTIONS
  • Rating of Asset implies its probability of
    default.
  • Underlying each Asset is a pool of collateral or
    an obligor whose behavior is correlated.

20
Sector 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)

21
AA
AA
22
Step 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

23
Synthetic CDO
Eligible Investments

Assets
cash
Class A Class B Class C Equity
Sponsor/ Protection Buyer
SPV
fee
notes
contingent payment
cash
Reference portfolio
24
Example 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

25
Synthetic 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

26
Cash Flow CDO Structure

Market / Sponsor
SPV
Loan/Bond Portfolio
Class A Class B Class C Equity
notes
cash
cash
27
Cash 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

28
Cash 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
29
Cash 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
30
Multiple 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

31
Sample 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

32
Last, but Not Least
  • Legal Analyses - Transfer of Assets
  • - SPV Separation
  • - Governing Law
  • - Transaction Documents
  • - Rights of Noteholders

33
Additional 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

34
Request Information or CDO Evaluator at
  • Local SP Office
  • or
  • CDOevaluator_at_SandP.com

35
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