1. Structured Finance: Synthetic ABS
Prof. Ian Giddy
New York University

2. Structured Finance
Asset-backed securitization
Corporate financial restructuring
Structured financing techniques

3. Collateralized Debt Obligations
Collateralized loan obligations (CLOs)
Collateralized bond obligations (CBOs)

4. Collateralized Debt Obligations
Cash flow backed CLOs and CBOs
Market value backed CBOs
Synthetic CLOs

5. Cash Flow Backed CLOs BANK (SELLER) SALE OR ASSIGNMENT Motivations:
Free up capital
Lower cost of funding
Distressed loan arbitrage (3rd party sponsors)
BANK (SELLER)
LOANS
SALE OR
ASSIGNMENT
SPECIAL
PURPOSE
VEHICLE
ISSUES
LOANS
ASSET-BACKED
CERTIFICATES

6. CLO Transaction Structure

7. CLO Rating Criteria Initial Review On-Site Due Diligence
Originator’s credit evaluation system
Pool composition & stress testing
On-Site Due Diligence
Legal Integrity
Bankruptcy-remoteness of SPV
Validity of asset transfer to SPV
Perfection of security interests in underlying collateral
Determining Credit Enhancement

8. Source: Fitch, ”Bank CLOs: an Overview”

9. SPV Cash flow Backed CLOs Investors CREDIT ENHANCEMENT
Senior-Sub with priorities of cash flows
Cash reserve accounts
Letters of credit
Guarantees
LOANS
SPV
Investors
Cash
flows
ABS
flows

10. Senior-Sub CLO Structure

11. Cash Flow Backed CBOs MANAGER SALE Motivation:
Cash flow arbitrage (bonds have good returns relative to risk, but may be illiquid)
MANAGER
BONDS
SALE
SPECIAL
PURPOSE
VEHICLE
ISSUES
BOND
ASSET-BACKED
PORTFOLIO
CERTIFICATES

12. Cash Flow Backed CBOs
Cash flow CBOs are built around a pool of assets with predictable cash flows. As such, these structures are restricted to investments that meet minimum credit quality, tenor and expected recovery characteristics. The analysis of a cash flow deal and determination of credit enhancement is based on the expected probability of default, severity of loss, and timing of default and recovery of the assets in the pool.
The ongoing market price of collateral assets is not important in a cash flow deal. Instead, it is the ability of each asset to pay scheduled principal and interest that makes these deals successful.

13. Collateral cash flows meet ABS interest & principal needs
Cash Flow Backed CBOs
MANAGER
Selects portfolio
Collateral cash flows meet ABS interest & principal needs
BONDS
SPV
Investors
Cash
flows
ABS
flows

14. Market Value Backed CBOs
Motivation:
Price arbitrage (bonds are underpriced, and tradeable)
BONDS
MANAGER
SALE
SPECIAL
PURPOSE
VEHICLE
ISSUES
BOND
ASSET-BACKED
PORTFOLIO
CERTIFICATES

15. Market Value CBOs
A market value CBO can be generally described as an investment vehicle that capitalizes on the arbitrage opportunities that exist between high yielding investments and the lower cost funds of highly rated debt. The transaction is typically capitalized with multiple classes of rated debt and a layer of unrated equity and invests in a pool of investments that is diverse in obligor, industry, and, frequently, asset class. In order to gauge the performance of the transaction, the asset manager will mark the value of each investment to market on a regular basis, usually weekly or biweekly.

16. Market Value Backed CBOs
MANAGER
Trades bonds to meet interest & principal needs
BONDS
SPV
Investors
ABS
flows
Cash
flows

17. Characteristics of Market Value CBOs
Market value transactions are often collateralized by leveraged loans, high-yield bonds, mezzanine debt, distressed debt, and public and even private equity.
Market value transactions are less restrictive with respect to cash flow requirements, credit quality, and maturity of the collateral.
The manager can trade the securities.

18. Rating Agencies Analyze Price Volatility to Determine CE Requirements

19. Advance rates determine how much rated debt can be issued against the market value of an asset.

20. Example of Market Value CBO Asset Mix and Financing

21. Asset-Backed Securities: The Typical Structure
FORD (SPONSOR)
LOANS.
Servicing Agreement
SALE OR
ASSIGNMENT
SPECIAL
PURPOSE
VEHICLE
ISSUES
LOANS.
ASSET-BACKED
CERTIFICATES

22. The Alternative: Synthetic ABS
DB (Originator)
REFERENCE
POOL OF LOANS
(Stay on
balance sheet)
CREDIT SWAP
AGREEMENT
SPECIAL
PURPOSE
VEHICLE
ISSUES
TOP QUALITY
ASSET-BACKED
INVESTMENTS
CERTIFICATES

23. Synthetic ABS or Collateralized Loan Notes
CLNs are SPV debt backed by the credit of the selling bank (or better)
No loans are sold to the SPV
But performance is based on the performance of a reference pool of loans
If the reference credits perform, full debt service is made on the CLN
If the reference credits default, the CLN is deemed “defaulted”and payment is halted.

24. Synthetic ABS GERMAN BANK (Originator) REFERENCE POOL OF LOANS
(Stay on
Balance Sheet)
CREDIT
SWAP
AGREEMENT
SPECIAL
PURPOSE
VEHICLE
TOP QUALITY
INVESTMENTS
ISSUES
ASSET-BACKED
CERTIFICATES

25. Synthetic ABS GERMAN BANK (Originator) REFERENCE POOL OF LOANS
(Stay on
Balance Sheet)
PROTECTION against
POOL DEFAULTS
EURIBOR
plus
“PREMIUM”
SPECIAL
PURPOSE
VEHICLE
TOP QUALITY
INVESTMENTS
ISSUES
ASSET-BACKED
CERTIFICATES

26. Credit Swaps in Synthetics: Doubts
Problems with the collateral
Debates about “events of default”
Workouts and other pre-default losses
Problems with the sponsor bank
Obtaining title to the collateral
Those “high quality investments”
And all those swaps

27. Typical Credit Default Swap Arrangement
BANK
SPV
REFERENCE
POOL OF LOANS
ABS
Deposit and
credit guarantee
The guarantee:
Pledge of a deposit in the sponsor bank
Part or all of that deposit will be forfeited if there are pool losses
“Losses in the transaction are defined as amounts
written off in compliance with the bank’s usual procedures”

28. Leveraged CDO (Super Senior Tranche)

29. Promises, Promises

30. Promising

31. Case Study: Global High Yield Bond Trust
What is the legal structure of this deal?
What are the assets?
What are the different classes of securities, and their terms?
How do the synthetic CLOs work? (Draw a diagram)
Should investors buy the subordinated tranche?

32. Global High Yield Bond Trust

37. Contact Info
Ian H. Giddy
NYU Stern School of Business
Tel ; Fax