Cash Flow Modelling For Securitisation - CDO
Broad Outline of CDO Primer Course (2 days Theory & Practical)
The object of the course
would be to provide a primer in CDOs for securitisation professionals.
This would be structured as a 2 days course based in Excel. The course
would use a single Excel model as a tool to take the delegates from the
basic stages of understanding CDOs as a capital markets project to the
more complicated facets of rating agencies’ approach.
As
a guide the delegates will be given an offering circular of Lafayette
Sovereign CDO from which the Excel programme was based. As part of the
exercise they will go through a process of reverse engineering the various
features of the CDO which are reflective of the market as a whole.
Key
points of the course will be:
- Understanding
the definitions of principal and revenue.
- Interpreting
the priority of payments from the offering circular to define the
application of funds (principal and interest).
- Use
of cross currency and interest rate swaps.
- Looking
at swap termination payments.
- Deriving
recovery payments from the assets.
- Use
of credit linked notes in structures.
- Use
of interest coverage and overcollateralisation ratios as a means of
providing extra leverage.
- Use
of principal transfer ledgers as a means of providing additional
liquidity.
- Calculating
residual payments based on targeted IRRs.
- Different
rating approaches by the rating agencies
-
Moody’s terminology and approach to CDOs
-
Standard & Poor’s terminology and approach to CDOs
-
Fitch’s terminology and approach to CDOs
Introduction & Advance CDO Structures (1 day – Theory & Practical)
The module will look at the Moody's Binomial Expansion Method for analysing CDO structures. The Binomial Expansion Method relies on the diversity score concept to equate a pool of bank loans or bonds to a virtual pool of homogeneous assets with a zero default correlation. The course will then take an Excel model that shows how the Binomial Expansion Method works in practice simulating the effects on the loss severity of defaulting between 1 and the total number of binomial loans. This advanced module looks into the more advanced aspects of Moody’s CDO analysis. In particular the use of different interest rate and default scenarios for deriving expected losses. Furthermore the module allows the delegates to look at more realistic portfolio compositions where assets groups are non granular.
Click here to view PDF of Excel workbook from module
Standard & Poor’s Approach to CDOs (2 hours – Theory & Practical)
Standard & Poor’s are now in their 3rd version of the CDO Evaluator. The module looks at how the CDO Evaluator is used as a collateral analysis tool to derive a series of ratings based default probabilities. Other parts of the module look at how to use the CDO Evaluator and the various stress tests used by Standard & Poor’s.
Click here to view PDF of Excel workbook from module
Fitch Rating’s Approach to CDOs (3 Hours – Theory & Practical)
Fitch have recently revised their approach to CDOs completely in an effort to make their CDO analysis more relevant against the other two rating agencies. The module will focus on their new Default Vector model. It will include the following aspects: what is the definition of default? Determination of asset quality – corporate debt, structured finance securities and SMEs. Fitch’s default matrix, default vector methodology, correlation between and amongst industry groups, correlation between geographic regions, correlation between structured products, default risk in revolving transactions, loss severity and recovery rates and cash flow modelling assumptions.
Click here to view PDF of PowerPoint from module
Cash Flow Stress Testing for CDOs (2 hours – Practical)
Having defined the different stress tests used by the rating agencies (Moody’s Investors Service, Standard & Poor’s and Fitch) used in CDO assets. The delegates will use an Excel cash flow model to tranche a CDO into their optimum structures using a ratings related default probability and loss severity.
Click here to view PDF of Excel workbook from module
Moody’s Approach to Emerging Market Credits – (Theory and Practical 3 Hours)
Although there are some exceptions, Moody’s uses this approach for all credits who are domiciled in sovereigns whose rating is Aa2. This module addresses the Moody’s 2004 update in which they completely revise their diversity score calculation for these type of assets. The criteria depends on a new approach where the assets are assigned (i) a geographical region (ii) a country approach (iii) a meta-industry. Using the above and the respective ratings of any 2 assets, it is possible do calculate the pair-wise correlation factor. The derivation of the diversity score uses the “two-moment” approach devised in the Repackaging Criteria. For the practical session, the focus is on recreating Moody’s proprietary model in Excel using both spreadsheets and user defined functions in VBA. The delegates will be given a template spreadsheet with a selection of sample data and build the workbook from scratch.
Click here to view PDF of Excel workbook from module
Using Credit Linked Notes as Collateral and Overcoming the Programming Issues (2 Hours Practical & Theory)
The use of credit linked
notes is gaining a wider audience as issuers wish to increase the weighted
average margin on their portfolio. However, the rating agencies’
recognise that their inclusion will result in greater risk, with the
effects of default if the credit linked issuer. The module examines how
all the rating agencies analyse this feature including the use of
Moody’s double binomial relating the probability of the reference asset
default with that of the programme issuer. The practical session uses a
fully functional Excel programme to examine the following features: use of
Moody’s double binomial; FX risk on CLN recoveries; calculating the
different recovery rates for CLN’s; diversity score for CLN issuers.
Click here to view PDF of Excel workbook from module
Overcollateralisation and Interest Coverage Ratios – Developing User Defined Functions (2 Hours Practical & Theory)
whilst these concepts are
now standard property of most cash flow deals they present unique
programming issues when I incorporating them into Excel based model. The
module looks at how to devise methods of calculating the correct target
amount of revenue to trap to within the structure without using iterative
methods. The practical sessions will analyse a selection of pre-built user
defined functions in Excel VBA for multi tranche CDOs. The last set will
require the delegate to design their own user defined functions for
interest coverage calculation in VBA (no previous VBA skills will be
required).
Click here to view PDF of Excel workbook from module
Using Interest Rate & Currency Swaps in CDOs Structures (2 Hours Practical & Theory)
the use of interest rate
and cross currency swaps in securitisations raises many questions. In a
number of vehicles the breakage costs are mutually ignored, in other deals
they are subordinated to rated notes. The module looks at the rating
agencies’ assumptions for defaults, interest and currency rates. The
practical session shows how the programming can deal with termination
payments on the swaps and their relative subordination.
Click here to view PDF of Excel workbook from module
Cash Flow Testing for Fitch, Moody’s and Standard & Poor’s CDO Assumptions (Practical 2 Hours)
Using a fully working Excel model based on a cash flow CDO, the delegates will run the model through a number of different scenario for each of the rating agencies. The module will include: importing default probability matrices from Fitch and Standard & Poor’s models, running single and double binomial runs, optimising the tranche sizes, using overcollateralisation and interest coverage triggers to reduce increase leverage and running the numerous default and interest rate scenarios.
Click
here to view PDF of Excel workbook from module
Moody’s Two Moment Approach for Multi Sector CDOs (Theory and Practical 3 Hours)
Taken from the publication “Moody’s Approach to MultiSector CDOs”, the module will look at the unique method of measuring the diversity score for a portfolio. Whilst the Moody’s research piece is useful, the module will go further in determining the correlation assumptions for the different asset groups. During the practical session. The delegates will use and build a diversity score model for multi-sector assets taking into account the asset group, the rating, WAL, % of underlying deal and by using user defined functions. The module will also look at the different recovery rates for different asset types.