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Tranche ABX and Basis Risk in Subprime RMBS Structured Portfolios. Kevin Kendra February 20, 2007. Introduction. What are structured subprime RMBS portfolios? What is “basis risk”? Why is “basis risk” between these structures important now?. What are structured subprime RMBS portfolios?. - PowerPoint PPT Presentation
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Tranche ABX and Basis Risk in Subprime RMBS Structured Portfolios
Kevin Kendra
February 20, 2007
Introduction
What are structured subprime RMBS portfolios?
What is “basis risk”?
Why is “basis risk” between these structures important
now?
www.derivativefitch.com 3
What are structured subprime RMBS portfolios?
> Portfolio exposure to subprime Residential Mortgage-Backed Securities
(RMBS) can be obtained using various structures:
– Structured Finance Collateralized Debt Obligations (SF CDOs)
> Cash SF CDOs
> Bespoke SF CDOs
> Hybrid SF CDOs
– ABX.HE Indices
– Tranche ABX.HE (TABX) Indices
www.derivativefitch.com 4
What is “basis risk”?
> Basis risk describes the risk that offsetting investments in a hedging strategy
will not experience cash flow or price gains in the same manner.
> Basis risk has the potential to create an excess gain or loss and therefore is
not directional. The amount of basis risk in a hedging strategy describes the
how much risk is left behind due to imperfect correlation between the two
investments.
> Basis risk in subprime RMBS portfolios generally arises from:
– Performance differences in the underlying portfolio assets
– Structural differences in portfolio instruments
– Liquidity differences in the different secondary markets
– Timing of expected cash flows from the portfolio instruments
www.derivativefitch.com 5
Why is “basis” between these structures important now?
> Standard tranches of the ABX.HE Index commenced trading on Feb. 14, 2007
> Index tranches promise to provide:
– Liquidity
– Transparency
– Standardization
– Market Consensus
> Motivations for TABX participation:
– Hedging
– Relative Value Trading
– Benchmarking
– Leveraged Market Positions
www.derivativefitch.com 6
Framework for Understanding Basis Risk in Subprime RMBS Portfolios
> Subprime RMBS 101
> Credit Default Swaps on Subprime RMBS
– Credit Default Swaps 101
– ISDA Pay-As-You-Go Template 101
– Subprime RMBS AFC Risk
> Typical Subprime RMBS Portfolio Structures
– Structured Finance CDOs 101
– ABX.HE and TABX.HE Indices 101
> Basis Risk between TABX.HE and Other Structures
Subprime RMBS Overview
Subprime RMBS 101
www.derivativefitch.com 8
Subprime RMBS 101
> Typical Subprime Borrower and Loan Characteristics
– FICO credit score 650 and below
– Prior mortgage delinquencies are acceptable
– Bankruptcy filing within the last 3 to 5 years are acceptable
– Foreclosure within the last 3 to 5 years are acceptable
– Debt-to-Income (DTI) ratios of 40% or higher
– Loan-to-Value (LTV) ratios greater than 80%
www.derivativefitch.com 9
Subprime RMBS 101
> Typical Subprime Loan Types
– Hybrid Adjustable-Rate Mortgages (ARMs)
> 2/28 Mortgage is fixed for the first two years and then switches to
adjustable rate for the remaining 28 years
> Other common Hybrid ARMs 3/27 and 5/25 terms
– Hybrid Interest Only (IO) ARMs
– 40-Year Hybrid ARMs
– Piggyback Second Liens
– Limited Documentation Loan Programs
www.derivativefitch.com 10
Subprime RMBS 101
2/28Hybrid ARM
MortgagePool
Fixed RateMortgage
‘AAA’RMBS
MortgagePools
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBSBonds
SpecialPurposeVehicle(RMBSTrust)
REMICTrust
Individual Mortgages
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
M31 M32 M33 M34 M35 M36 M37 M38 M39 M40
M41 M42 M43 M44 M45 M46 M47 M48 M49 M50
M51 M52 M53 M54 M55 M56 M57 M58 M59 M60
M61 M62 M63 M64 M65 M66 M67 M68 M69 M70
M71 M72 M73 M74 M75 M76 M77 M78 . . .M
2000
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
M31 M32 M33 M34 M35 M36 M37 M38 . . .
M1000
Sample Subprime RMBS Structure
www.derivativefitch.com 11
Subprime RMBS 101
Interest
ScheduledPrincipal
&Prepayments
‘AAA’L + % or Net WAC
Accounts
‘AA’L + % or Net WAC
‘A’L + % or Net WAC
‘BBB’L + % or Net WAC
‘BBB-’L + % or Net WAC
ResidualExcess Interest
Servicer
REMICTrust
Monthly MortgagePayments
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
M31 M32 M33 M34 M35 M36 M37 M38 M39 M40
M41 M42 M43 M44 M45 M46 M47 M48 M49 M50
M51 M52 M53 M54 M55 M56 M57 M58 M59 M60
M61 M62 M63 M64 M65 M66 M67 M68 M69 M70
M71 M72 M73 M74 M75 M76 M77 M78 . . .M
2000
M1 M2 M3 M4 M5 M6 M7 M8 M9 M10
M11 M12 M13 M14 M15 M16 M17 M18 M19 M20
M21 M22 M23 M24 M25 M26 M27 M28 M29 M30
M31 M32 M33 M34 M35 M36 M37 M38 . . .
M1000
$
$
$ P
$ I
InterestPayments
PrincipalPayments
‘AAA’
‘AA’
‘A’
‘BBB’
‘BBB-’
Residual
$ I
$ P
ScheduledPrincipal
&Prepayments
Sample Subprime RMBS Payments
www.derivativefitch.com 12
Subprime RMBS 101
> Standard Structural Features of Subprime RMBS
– Subordination serves as credit enhancement to account for credit risk
– Interest rate instruments to hedge interest rate risk
– Performance test at three year mark
> If test fails then the priority of payments remains unchanged with the
senior notes receiving all principal proceeds
> If test passes then principal proceeds repays subordinated notes until
targeted subordination is met.
– Defaulted loans worked out by servicers
> Each Subprime RMBS will have somewhat unique performance profiles
www.derivativefitch.com 13
Subprime RMBS 101
Principal Waterfalls
– Sequential pay
> All scheduled principal and prepayments go to repay the senior bond holders
first until paid-in-full, then to the next senior note holder, etc.
> Subprime RBMS are initially sequential pay for the first three years and will
remain sequential pay if the performance tests fail
– Credit Enhancement (CE) “Step Downs”, if performance tests pass
> If overcollateralization (OC) targets have been met, the CE is stepped down by
repaying subordinate bond holders.
> OC targets are set to double the original subordination, ie. If the original ‘AAA’
bond subordination is 7.5% then the target is 15%
> Test senior note target for compliance first and if passing then check the next
senior bond and so on.
> Over periods of rapid prepayments all bonds may be meeting the OC targets,
then principal prepayments become inverse sequential pay.
www.derivativefitch.com 14
Sample Principal Waterfalls
ScheduledPrincipal
&Prepayments
AccountsPrincipalPayments
‘AAA’
‘AA’
‘A’
‘BBB’
‘BBB-’
Residual
$ P
PaymentsBefore Step Down
Scenario 1: Sequential Principal Repayment
ScheduledPrincipal
&Prepayments
AccountsPrincipalPayments
‘AAA’
‘AA’
‘A’
‘BBB’
‘BBB-’
Residual
$ P
Scenario 2: Performance Test Passes the CreditEnhancement “Steps Down” by Paying Principal
to Subordinated Notes
After Step Down
PaymentsBefore Step Down
After Step Down
www.derivativefitch.com 15
Subprime RMBS 101
Interest Waterfalls
– Regular interest
> Paid sequentially to bonds, capped at weighted average mortgage
rate net of expenses (Net WAC) or available funds cap (AFC)
– Excess Interest
> Excess interest is the remaining interest proceeds in the interest
collection account after paying bondholders regular interest above
> First, excess interest is used to recover realized collateral losses
> Second, excess interest is used to recover any interest shortfalls
created where Net WAC is lower than the stated bond coupon
> Finally, the remaining excess interest goes to the residual bond holder
www.derivativefitch.com 16
Sample RMBS Interest Waterfall
Interest
‘AAA’L + % or Net WAC
Accounts
‘AA’L + % or Net WAC
‘A’L + % or Net WAC
‘BBB’L + % or Net WAC
‘BBB-’L + % or Net WAC
ResidualExcess Interest
InterestPayments
PrincipalPayments
‘AAA’
‘AA’
‘A’
‘BBB’
‘BBB-’
Residual
$ I
ScheduledPrincipal
&Prepayments
Losses
InterestShortfalls
L + % - Net WAC
Step 1 – Interest Paid Sequentiallyto Bonds, Capped
at AFC
L + % - Net WAC
Step 2 – ExcessInterest to
Cover CollateralLosses
Step 3 – RemainingExcess Interest to Pay AFC Shortfalls
Step 4 – RemainingExcess Interest to
Residual Holder
www.derivativefitch.com 17
Subprime RMBS 101
AFC Interest Shortfall
– AFC Shortfall is the difference between the stated bond coupon and the
Net WAC
– AFC Shortfalls accrue over time and may be recoverable
– AFC Shortfalls manifest themselves in times of rising interest rates
> Typical subprime RMBS deals have 75% hybrid ARM mortgages
> RMBS bonds are generally floating rate bonds based on the London
InterBank Offering Rate (LIBOR)
> If short-term LIBOR interest rates rise during the 2- or 3-year fixed rate
period then the interest coupon from the mortgages is insufficient to
pay the RMBS bond holders LIBOR plus the stated spread
– AFC shortfalls may be unrecoverable if excess interest is eroded.
Credit Default Swaps on Subprime RMBS
Credit Default Swaps (CDS) 101
ISDA Pay-As-You-Go (PAUG) Template 101
Subprime RMBS AFC Risk
www.derivativefitch.com 19
Credit Default Swaps 101
Protection Seller
– Receives CDS premium payment and reimbursement payments in
exchange for providing protection payments if a credit event occurs.
– CDO note holders are protection sellers in a synthetic CDO.
Protection Buyer
– Pays CDS premium in exchange for protection payments if a credit event
occurs.
– CDS Swap Counterparty is the protection buyer in a synthetic CDO.
Calculation Agent
– Determines the amount of the protection payment upon a credit event per
the terms of the credit default swap
– Usually the Protection Buyer serves this role
www.derivativefitch.com 20
Credit Default Swaps 101
Collateral or Eligible Investment
– Highly rated, highly liquid financial instruments purchased from the sales
proceeds of the initial CDO notes.
– Provides the index portion of the note coupon
– Provides protection payments or the return of principal to note holders
Reference Entity and Reference Obligation
– Reference entities are security issuers like a corporation or sovereign
– Reference obligations are securities with specific debt seniority levels
> Reference obligations in a corporate CDS is usually informational to
establish the seniority of debt to be valued if a credit event occurs
> Reference obligations in CDS of structured finance assets or
leveraged loans or in total return swap structures
www.derivativefitch.com 21
Credit Default Swaps 101
Credit-LinkedNote Trust
CDS Premium(bps)
Credit DefaultSwap
ProtectionSeller
CDS SwapCounterparty
ProtectionPayments ($)
Note Coupon(L + bps)
ProtectionBuyer
ProtectionSeller
CLN Proceeds($)
Collateral orEligible
Investments
ReferenceEntity or
Obligation
CLN Proceeds
($)LIBOR
(L)
Sample Credit-Linked Note (CLN) using a CDS
www.derivativefitch.com 22
Credit Default Swaps 101
Credit Events
– Applicable credit events will vary by CDS
– Typical credit events may include:
> Bankruptcy
> Failure to Pay (FTP)
> Restructuring
> Repudiation/Moratorium, usually emerging markets and sovereigns only
> Obligation Acceleration, usually emerging markets sovereigns only
– Once a credit event has been called and settled then the credit default swap
is terminated
www.derivativefitch.com 23
Credit Default Swaps 101
Settlement and Valuation Procedures
– Protection Buyer calls a credit event by sending notice to the Protection
Seller what credit event has occurred
– Settlement method is determined by the CDS contract
> Physical settlement means the Protection Buyer gives the Seller the
reference obligation, or equivalent, in return for cash par amount
> Cash settlement means the parties look to the market value of the
reference obligation to determine the net protection payment
– Fitch’s preferred valuation process includes:
> Dealer poll of at least 5 dealers, not including the Protection Buyer
> Polls typically held 30 to 60 days after credit event notification
www.derivativefitch.com 24
ISDA Pay-As-You-Go (PAUG) Template 101
> ISDA PAUG template is designed to replicate the cash flow profile of the cash
bond with a credit default swap (CDS) contract
> CDS contracts for corporate and sovereign issuers are insufficient to replicate
the payment profile of a structured finance bond
> ISDA PAUG template was introduced in the U.S. in XXXX 2005 for RMBS and
CMBS securities for CDO securities in June 2006
> Introduces the concept of “floating payments”
– Floating payments are paid by the Protection Seller in the event of an AFC
Interest Shortfall
– Floating payments may be reimbursed by the Protection Buyer if the AFC
Interest Shortfall is ultimately recovered
www.derivativefitch.com 25
ISDA Pay-As-You-Go (PAUG) Template 101
Credit-LinkedNote Trust
CDS Premium(bps)
Credit DefaultSwap
ProtectionSeller
CDS SwapCounterparty
ProtectionPayments ($)
Note Coupon(L + bps)
ProtectionBuyer
ProtectionSeller
CLN Proceeds($)
Collateral orEligible
Investments
ReferenceObligation
CLN Proceeds
($)LIBOR
(L)
Sample CLN using a PAUG CDS
FloatingPayments
www.derivativefitch.com 26
ISDA Pay-As-You-Go (PAUG) Template 101
PAUG Credit Events
– Failure to Pay (FTP) Principal
– Writedown
– Distressed Rating Downgrade (‘CCC’ or below)
– FTP Interest for CDO reference obligations only
PAUG Floating Amount Events
– Interest Shortfalls
– Principal Shortfalls
– Writedown Amounts
> Protection Buyers typically have an option whether to call a credit event or a
floating amount event
www.derivativefitch.com 27
ISDA Pay-As-You-Go (PAUG) Template 101
PAUG Settlement
– The secondary market for structured finance securities is not liquid and
therefore valuation procedures are not applicable
– Floating payments are designed to replicate the actual loss amounts
– If a credit event occurs then the Protection Buyer has the option to physically
deliver all or part of the notional amount to the Seller
> If the entire notional is physically settled then the CDS is terminated
> If a portion of the notional is settled then the CDS continues on the
remaining amount
www.derivativefitch.com 28
ISDA Pay-As-You-Go (PAUG) Template 101
Interest Shortfalls
– RMBS reference obligations are called AFC shortfalls
– CMBS reference obligations are called WAC shortfalls
– CDO reference obligations are called PIK-ing shortfalls
Interest Shortfall Cap Options
– Fixed Cap: Floating payments are limited to the amount of the CDS premium
– Variable Cap: Floating payment are limited to LIBOR + premium
– No Cap: No limit to the floating rate payments
> Completely replicates the payments of the cash bond or total return swap
> May require principal to be liquidated to pay interest shortfall
www.derivativefitch.com 29
Subprime RMBS AFC Risk
> Available Funds Cap (AFC) Risk
– REMIC law limits a floating rate RMBS bond pass-through rate to the
lesser of:
> Bond spread plus some index (typically 1 month LIBOR), or
> Underlying mortgage collateral pool’s weighted average coupon, net
of expenses (Net WAC).
– AFC Risk varies by RMBS transaction based on:
> Actual prepayment speeds of underlying mortgages
> Effectiveness of interest rate hedges in the RMBS structure
> Short-term interest rate increases before Hybrid ARM mortgages
switch to floating interest rate payments
www.derivativefitch.com 30
Subprime RMBS AFC Risk
Initial Rating 2001 2002 2003 2004 2005 2006
AAA 0.00% 0.00% 0.00% 0.69% 0.50% 0.00%
AA+ 0.00% 0.00% 0.00% 4.81% 0.96% 0.00%
AA 0.00% 0.00% 0.00% 3.09% 2.24% 0.00%
AA- 0.00% 0.00% 0.00% 6.67% 1.05% 0.00%
A+ 0.00% 0.00% 0.00% 7.46% 3.46% 0.33%
A 0.00% 0.00% 0.93% 4.56% 3.35% 0.77%
A- 0.00% 0.00% 6.56% 5.18% 6.71% 0.75%
BBB+ 0.00% 0.00% 4.95% 10.12% 13.51% 2.96%
BBB 0.00% 0.00% 7.17% 10.10% 19.34% 6.67%
BBB- 0.00% 0.00% 2.77% 16.13% 25.49% 18.17%
BB+ 0.00% 0.00% 0.00% 11.11% 23.00% 33.25%
BB 0.00% 0.00% 0.00% 2.62% 18.04% 35.38%
RMBS Bonds that Experience Unrecovered AFC Interest Shortfalls
> Unrecovered AFC Interest Shortfalls can be prevalent by vintage
> Unrecovered AFC Interest Shortfalls can be present across all rating categories
www.derivativefitch.com 31
Key Risks – AFC Risk
Initial Rating 2001 2002 2003 2004 2005 2006
AAA 0.00% 0.00% 0.00% 0.01% 0.03% 0.00%
AA+ 0.00% 0.00% 0.00% 0.04% 0.21% 0.00%
AA 0.00% 0.00% 0.00% 0.08% 0.22% 0.00%
AA- 0.00% 0.00% 0.00% 0.06% 0.20% 0.00%
A+ 0.00% 0.00% 0.00% 0.08% 0.27% 0.05%
A 0.00% 0.00% 0.01% 0.05% 0.31% 0.04%
A- 0.00% 0.00% 0.07% 0.05% 0.06% 0.05%
BBB+ 0.00% 0.00% 0.16% 0.08% 0.09% 0.04%
BBB 0.00% 0.00% 0.18% 0.19% 0.07% 0.04%
BBB- 0.00% 0.00% 0.64% 0.22% 0.08% 0.05%
BB+ 0.00% 0.00% 0.00% 0.34% 0.13% 0.03%
BB 0.00% 0.00% 0.00% 0.11% 0.12% 0.03%
Cumulative Unrecovered AFC Interest Shortfalls as % of Bond Balance
> Unrecovered AFC Interest Shortfall amounts have been small
> Difference in CDS premium required for No Cap protection may exceed the actual
unrecovered AFC interest shortfalls experience in the cash bond market
Subprime RMBS Portfolio Structures
Structured Finance CDOs 101
ABX.HE and TABX.HE 101
www.derivativefitch.com 33
Structured Finance CDOs 101
> Generic Types of SF CDOs
– Cash SF CDOs
– Bespoke SF CDOs
– Hybrid SF CDOs
www.derivativefitch.com 34
Structured Finance CDOs 101
‘AAA’CDO
‘AA’CDO
‘A’CDO
‘BBB’CDO
Preferred Sharesor Equity
CDOBonds
SpecialPurposeVehicle(CDOTrust)
CDOTrust
CDO Portfolio
CDOBond 1
Sample Cash SF CDO Structure
CDOBond 3
CDOBond 4
CDOBond 5
CDOBond 2
RMBSBond 1
RMBSBond 3
RMBSBond 4
RMBSBond 5
RMBSBond 2
RMBSBond 6
RMBSBond 8
RMBSBond 9
RMBSBond 10
RMBSBond 7
RMBSBond 11
RMBSBond 13
RMBSBond 14
RMBSBond 15
RMBSBond 12
RMBSBond 16
RMBSBond 18
RMBSBond 19
RMBSBond 20
RMBSBond 17
RMBSBond 21
RMBSBond 23
RMBSBond 24
RMBSBond 25
RMBSBond 22
RMBSBond 26
RMBSBond 28
RMBSBond 29
RMBSBond 30
RMBSBond 27
RMBSBond 31
RMBSBond 33
RMBSBond 34
RMBSBond 35
RMBSBond 32
RMBSBond 36
RMBSBond 38
RMBSBond 80
RMBSBond 37 . . .
CDOBond 6
CDOBond 8
CDOBond 9
CDOBond 10
CDOBond 7
Note Coupon(L + bps)
Proceeds($)
Bond Coupons(L + bps)
Proceeds($)
www.derivativefitch.com 35
Structured Finance CDOs 101
> Cash SF CDO Asset Portfolio Highlights
– Portfolios contain between 60 and 140 bonds
– Assets may be diversified by market sector, however recent vintage SF
CDOs have been concentrated in subprime RMBS
– Assets may be diversified by risk profile (intial ratings)
– Assets may be diversified by vintage
– Asset acquisition and selection
> Asset manager warehouses bonds prior to issuing CDO notes
> CDO notes typically issued when asset manager has accumulated
approximately 60-80% of the target portfolio
> Initial portfolio is typically fully ramped within 6 months of CDO note
issuance
www.derivativefitch.com 36
Structured Finance CDOs 101
> Managed vs Static Portfolios
– Static portfolios are typically fully ramped at closing and principal proceeds
are used to amortize the senior notes
– Managed portfolios are typically partially ramped at closing and principal
proceeds are typically reinvested for a finite period between 3 and 6 years
> If the portfolio experiences negative credit migration then discretionary
trading is limited to “maintain or improve” credit quality
> If the portfolio significantly under performs then the transactions may
shift to a static portfolio
www.derivativefitch.com 37
Structured Finance CDOs 101
> Cash SF CDO Note Highlights
– Credit enhancement comes from subordination and excess spread
– Interest is paid sequentially to note holders
– Overcollateralization (OC) and Interest Coverage (IC) performance tests
are checked prior to distributions to subordinate notes
– Excess interest may be used to:
> If tests are passing then distributed to Preferred Shares or Equity
> A portion may be used to repay mezzanine notes
> If tests are failing then distributions may be used to cure the tests
– Purchase new assets
– Pay down senior notes
www.derivativefitch.com 38
Structured Finance CDOs 101
UnfundedSuper-Senior
Revolver
First Loss
CDOStructure
SpecialPurposeVehicle(CDOTrust)
CDOTrust
Reference Portfolio
Sample Bespoke SF CDO Structure
CDSPremium
ProtectionPayments
‘AAA’Note
Proceeds($) Unfunded
CDS
UnfundedCDS
NoteCoupon(L + bps)
Collateral orEligible
Investments
Proceeds($)
LIBOR(L)
RMBSBond 1
RMBSBond 3
RMBSBond 4
RMBSBond 5
RMBSBond 2
RMBSBond 6
RMBSBond 8
RMBSBond 9
RMBSBond 10
RMBSBond 7
RMBSBond 11
RMBSBond 13
RMBSBond 14
RMBSBond 15
RMBSBond 12
RMBSBond 16
RMBSBond 18
RMBSBond 19
RMBSBond 20
RMBSBond 17
RMBSBond 21
RMBSBond 23
RMBSBond 24
RMBSBond 25
RMBSBond 22
RMBSBond 26
RMBSBond 28
RMBSBond 29
RMBSBond 30
RMBSBond 27
RMBSBond 31
RMBSBond 33
RMBSBond 34
RMBSBond 35
RMBSBond 32
RMBSBond 36
RMBSBond 38
RMBSBond 80
RMBSBond 37 . . .
CDS SwapCounterparty
www.derivativefitch.com 39
Structured Finance CDOs 101
> Bespoke SF CDO Asset Portfolio Highlights
– Portfolios reference between 60 and 100 securities
– Assets may be diversified by market sector but typically have a
concentration in subprime RMBS
– Assets may be diversified by risk profile (initial ratings
– Assets may be diversified by vintage
– Asset selection
> Portfolio is negotiated between the Bespoke CDO note holder and the
CDS Swap counterparty
www.derivativefitch.com 40
Structured Finance CDOs 101
> Bespoke SF CDO Note Highlights
– Attachment points define the amount of portfolio losses the structure
needs to sustain before a protection payment would be made
– Detachment point defines the maximum amount of protection payments
that the notes could be required to make
– Credit enhancement comes solely from subordination
www.derivativefitch.com 41
Structured Finance CDOs 101
UnfundedSuper-Senior
Revolver
‘AA’CDO
‘A’CDO
‘BBB’CDO
Preferred Sharesor Equity
CDOStructure
SpecialPurposeVehicle(CDOTrust)
CDOTrust
CDS Portfolio
CDOCDS 1
Sample Hybrid SF CDO Structure
CDOCDS 3
CDOCDS 4
CDOCDS 5
CDOCDS 2
RMBSCDS 1
RMBSCDS 3
RMBSCDS 4
RMBSCDS 5
RMBSCDS 2
RMBSCDS 6
RMBSCDS 8
RMBSCDS 9
RMBSCDS 10
RMBSCDS 7
RMBSCDS 11
RMBSCDS 13
RMBSCDS 14
RMBSBond 15
RMBSCDS 12
RMBSCDS 16
RMBSCDS 18
RMBSCDS 20
RMBSCDS 17
. . .
Bond Portfolio
CDOBond 1
CDOBond 3
CDOBond 4
CDOBond 5
CDOBond 2
RMBSBond 1
RMBSBond 3
RMBSBond 4
RMBSBond 5
RMBSBond 2
RMBSBond 6
RMBSBond 8
RMBSBond 9
RMBSBond 10
RMBSBond 7
RMBSBond 11
RMBSBond 13
RMBSBond 14
RMBSBond 15
RMBSBond 12
RMBSBond 16
RMBSBond 18
RMBSBond 20
RMBSBond 17
. . .
Bond Coupons(L + bps)
Proceeds($)
CDS Premium
ProtectionPayments
‘AAA’CDO
Note Coupon(L + bps)
Proceeds($)
FundedNotes
UnfundedCDS
CDS Premium
Super-SeniorProtectionPayments
www.derivativefitch.com 42
Structured Finance CDOs 101
> Hybrid SF CDO Asset Portfolio Highlights
– Portfolio assets may be in a cash or synthetic form
– Portfolios contain between 60 and 140 bonds or CDS
– Asset attributes similar to the cash SF CDO portfolios
– Portfolios are typically managed
> Asset managers can find relative value on the same asset between
cash and synthetic markets
> Asset managers can use the synthetic market to access collateral
from vintages that are not available in the secondary market
> Asset managers can use the synthetic market to get full exposure to
cash bonds where they received a partial allocation
www.derivativefitch.com 43
ABX.HE and TABX.HE Indices 101
‘AAA’RMBS
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBS1
‘AAA’RMBS
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBS2
‘AAA’RMBS
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBS3
‘AAA’RMBS
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBS4
‘AAA’RMBS
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBS5
‘AAA’RMBS
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBS6
‘AAA’RMBS
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBS7
‘AAA’RMBS
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBS8
ABX.HE.AAA‘AAA’RMBS
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBS9
‘AAA’RMBS
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBS10
‘AAA’RMBS
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBS20
‘AAA’RMBS
‘AA’RMBS
‘A’RMBS
‘BBB’RMBS
‘BBB-’RMBS
Residual
RMBS11
. . .
. . .
. . .
. . .
. . .
. . .
. . .
ABX.HE.AA
ABX.HE.A
ABX.HE.BBB
ABX.HE.BBB-
www.derivativefitch.com 44
ABX.HE and TABX.HE Indices 101
> ABX.HE Asset Portfolio Highlights
– Portfolios reference 20 bonds
– Assets are all subprime RMBS
– Assets are homogenous by risk profile (intial ratings)
– Assets are originated in a 6 month time frame
– Asset selection
> Aggregate a list of the largest volume subprime RMBS issuers
> Select two representative transactions from each issuer
> Index participants vote on transactions to be included in each index
www.derivativefitch.com 45
ABX.HE and TABX.HE Indices 101
‘BBB’RMBS 1
‘BBB’RMBS 20
TABX.HE.BBBReference Obligations
‘BBB’RMBS 2
‘BBB’RMBS 3
‘BBB’RMBS 4
‘BBB’RMBS 5
‘BBB’RMBS 6
‘BBB’RMBS 7
‘BBB’RMBS 8
.
.
.
35 – 100%
20 – 35%
12 – 20%
7 – 12%
3 – 7%
0 – 3%
TABX.HE.BBBTranches
ABX.HE.BBB06-2 Portfolio
‘BBB’RMBS 1
‘BBB’RMBS 20
‘BBB’RMBS 2
‘BBB’RMBS 3
‘BBB’RMBS 4
‘BBB’RMBS 5
‘BBB’RMBS 6
‘BBB’RMBS 7
‘BBB’RMBS 8
.
.
.
ABX.HE.BBB07-1 Portfolio
www.derivativefitch.com 46
ABX.HE and TABX.HE Indices 101
> TABX.HE Asset Portfolio Highlights
– Portfolios reference 40 bonds from two ABX.HE indices
– Assets are all subprime RMBS
– Assets are homogenous by risk profile (intial ratings)
– Assets are originated in a one year time frame
Conclusions
www.derivativefitch.com 48
ABX.HE and TABX.HE Conclusions
> The ABX.HE has proven to be effective in providing market transparency in an
otherwise opaque market
– Allows market participant to express market views
> The TABX.HE promises to provide similar benchmarking and relative value
views for the Bespoke SF CDO market
> TABX.HE will be less effective in benchmarking for cash and hybrid SF CDOs
– Portfolios have significantly different portfolio characteristics
– Portfolios are typically managed in SF CDOs
– TABX.HE is equally weighted by the largest issuers whereby SF CDOs
portfolios are typically selected by an asset manager
www.derivativefitch.com
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