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November 2007 Overview of Collateralized Loan Obligations.

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Presentation on theme: "November 2007 Overview of Collateralized Loan Obligations."— Presentation transcript:

1 November 2007 Overview of Collateralized Loan Obligations

2 1 Table of Contents I.The CDO Market II.The CDO Structure III.Current Opportunities

3 2 The CDO Market

4 3 Where are we now?

5 4

6 5 Overview of CDOs Collateralized Debt Obligations (“CDOs”) are securities issued to finance a diversified pool of credits. The portfolio of securitized assets in a CDO is typically financed by a credit-tiered capital structure, consisting of both investment grade and non-investment grade tranches of debt, supported by an equity tranche. The majority of the financing for a CDO is usually provided by a large AAA rated tranche of debt, thereby making the weighted average cost of capital significantly cheaper than the return on the portfolio of assets. Below the rated debt tranches in the structure of a CDO is a tranche of Equity. This tranche is the beneficiary of the spread differential between the returns on the portfolio of assets and the weighted average cost of financing. What are CDOs?

7 6 Source: Bear Stearns CDO Research; as of September Issuance figures are as of closing date, and are subject to change as more information becomes available. The CDO Market Global issuance since 1997 has totaled $2.68 trillion Growth of the Global CDO Market ($Billions)

8 7 Source: Bear Stearns CDO Research; funded issuance. * As of August 31, The CDO Market CDO Issuance by Sector – U.S. (MM) Asset Class * Bank Loans$15,072$14,031$20,526$30,496$53,364$103,733 $79,469

9 8 Not All CDOs Are Created Equal US Mezz ABS CDO US CLO Diversity in CDOs

10 9 Not All CDOs Are Created Equal RMBS Source: LPS Loan Source: S&P’s LCD Subprime 60+ Delinquencies by Vintage Leveraged Loan Default Rates RMBS vs Leveraged Loans

11 10 Debt Service LIBOR+0.50% And Expenses 0.60% LIBOR+1.10% Total Costs = Preferred Shares $40 mm 8.0% The CDO Structure Assets $500 mm US Corporate Senior Secured Bank Loans Weighted Average Yield: LIBOR+2.30% CDO Special Purpose Vehicle Remaining Net Spread 1.20% $372 mm Aaa / AAA LIBOR+0.26% 74.4% Of Total Assets Liabilities $33 mm Aa2 / AA LIBOR+0.40% 6.6% $31 mm A2 / A LIBOR+0.70% 6.2% $20 mm Baa2 / BBB LIBOR+1.65% 4.0% $20 mm Ba2 / BB LIBOR+3.75% 4.0% 1.Capital structure modeled as of 7/2/2007

12 11 The CDO Structure 1.Defaults begin 2 periods after collateral is purchased, and are the indicated rate thereafter. The call rate of the loans is assumed to be 25% per annum, beginning after 1 period. Assumes a reinvestment spread of 2.40% in year 1, 2.50% in year 2 and 2.60% thereafter. Forward LIBOR used. Illustrative Sensitivity Analysis of Rated Debt Tranches 1

13 12 Immediate Recovery at 75% upon Default Illustrative Preferred Share Returns 1,2 1.Defaults begin 2 periods after collateral is purchased, and are the indicated rate thereafter. The call rate of the loans is assumed to be 25% per annum, beginning after 1 period. Assumes a reinvestment spread of 2.40% in year 1, 2.50% in year 2 and 2.60% thereafter. Forward LIBOR used. 2.Returns modeled as of 7/2/2007 The CDO Structure

14 13 The CDO Structure 1.Assumes transaction is called after 8.2 years, 3% Annual CDR, and Immediate Recovery at 75% upon default. 2.Defaults begin 2 periods after collateral is purchased, and are the indicated rate thereafter. The call rate of the loans is assumed to be 25% per annum, beginning after 1 period. Assumes a reinvestment spread of 2.40% in year 1, 2.50% in year 2 and 2.60% thereafter. Forward LIBOR used. Hypothetical CDO Equity Cash Flows ( expected IRR: 12-15%)

15 14 Source: Bear Stearns CDO Research. Simple average of monthly liability spreads for the given year. The CDO Structure Tranche H07Curren t AAA AA A BBB BB New Issue Liability Spreads 1H07Current

16 15 Current Opportunities Loan Source: S&P/LCD CLO Liability Spread Source: Bear Stearns CDO Research month lagging leveraged loan default rate by number of issuers. 2. S&P occasionally revises its published historical default rate data, and so the values shown are subject to change. 3. Source: Leveraged Loan Index 12-month lagging leveraged loan default rate by number of issuers. Opportunities for AAA investors AAA CLO Liability Spreads and Leveraged Loan Default Rate through September ,2,3 CLO spreads have moved with defaults in previous credit cycles. Because of the current market dislocation, spreads have increased significantly while defaults have remained low

17 16 Current Opportunities Loan Source: S&P/LCD CLO Liability Spread Source: Bear Stearns CDO Research month lagging leveraged loan default rate by number of issuers. 2. S&P occasionally revises its published historical default rate data, and so the values shown are subject to change. 3. Source: Leveraged Loan Index 12-month lagging leveraged loan default rate by number of issuers. Opportunities for BBB & BB investors CLO spreads have moved with defaults in previous credit cycles. Because of the current market dislocation, spreads have increased significantly while defaults have remained low BBB and BB CLO Liability Spreads and Leveraged Loan Default Rate through September ,2,3

18 17 Risk: Historical Average One Year Downgrade Risk CLO liabilities have experienced significantly less downgrades than comparably rated corporates Current Opportunities Downgrade Source: Moody’s Investor Services, “Credit Migration of CDO Notes, , for US and European Transactions” February 28, Baa3 and Ba3 ratings are deemphasized as debt rated at these levels is no longer commonly issued. Additionally, there were only 194 and 212 observations at the Baa3 and Ba3 levels, respectively, while there were 1230, 417, 684, and 363 observations for the Aaa, Aa2, Baa2, and Ba2 ratings, respectively. 2. Figures are from "theoretical" corporate transition matrix. Moody’s weighted each year’s one-year corporate transition rates by the number of CDO ratings outstanding at each rating level at the beginning of the year.

19 18 Current Opportunities CLOs allow investors to access the corporate credit markets CLO performance is not directly tied to Residential Mortgage Backed Securities The CLO structure allows investors to participate across the capital structure based on their preference for risk Uncertainty in the credit markets have caused CLO spreads to widen significantly In Conclusion


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