Financial Engineering and Structured Products

Transcription

1 Financial Engineering and Structured Products Week of March 24, 2014 Structured Finance Finish-Up Liability-Side Cash Flows & Midterm Review Plan for This Week Finish-Up Liability Side Cash Flows Liability Side CF protocol and hierarchy The Cash Flow Waterfall Types of Liabilities & PMB Fees Interest Principal & PMB Analysis of the Liability-Side CF Analysis of the Liability-Side CF Liabilities in a structured Transaction include any cost that must be paid from the cash generated by the assets Foremost are costs which enable the transaction Servicer, trust, rating agency fees, etc. Also paramount are fees that insure the integrity of the transaction e.g., CE & IR risk Swap fees/payments, insurance, etc. Finally, payment of principal & interest due to the parties (note holders) that funded the transaction 1.3 Types of Liabilities Three Basic Types (can be whole dollar or, more usually, as a percent of assets or debt balance) Fees Interest Principal PMB on Liability Side Liability Input on Inputs Page Sr/Sub Structure Structure Inputs on Input Page fees, reserve, etc. Generating Liability Cash Flows The raw deal as per R&R (groan) 1.4 1

2 Three types of Trigger(s) Loss protection Single most important rationale for credit enhancement Motivates these advanced liability structures 1.5 The simplest, most efficient, and most cost effective method of mitigating loss is by altering the structure of the transaction when problems arise In many deals, as investors see collateral starting to sour, they prefer to see their principal returned OTOH, early return of principal results in a lower yield and a shorter average life Conflict between payment speed and reward makes defining and setting a trigger tricky PMB defines some simple trigger structures 1.6 A classic trigger is based on cumulative default rate If a static pool of assets have an expected default rate of 3%, a transaction could set a trigger at 5% such that if breached there is a rapid amortization of senior principal Alternatives trigger definitions include Negative Excess Spread: If XS becomes negative Delinquency: If delinquencies exceed a specified level Rolling Average: Rather than a period test, a moving average is compared to a trigger breach level Qualitative: Could include trust missing a payment, failing to send reports, failing to meet any of a set of criteria 1.7 Trigger breach can force a variety of changes and consequences In the case of a breach not being very severe, it could mean trapping extra cash for a period and increasing minimum reserve to keep it in the deal Alternatively, for more severe cases, a deal could go into full rapid amortization with all cash being redirected to the senior tranches Provisions for trigger breaches to cure can also be specified Only quantitative triggers depending on CF state are usually modeled 1.8 2

3 Capture All XS used in stress test scenarios; all XS is used to pay down senior debt Capture All XS: Y/N No is OFF Boolean Indicator shows state of Capture All XS: T/F XS is used to accelerate the pay down of senior debt if T uses remaining cash at the end of the waterfall and applies to senior principal 1.9 Post Default Trigger Month implements the deferral of rapid amortization; allows a period for the continued release of cash Number of Months for Deferral Zero is OFF How about applying this idea to other triggers a wait period? To see if delinquencies cure Boolean Indicator shows state of Capture All XS: T/F 1.10 Default Trigger Per Cent Tracks Default and trips if Defaults Exceed a predefined level Default Trigger % Level to Trip Trigger SDA Curve? Cumulative Default Percentage is Tracked for each Period Boolean Indicator shows if the Default Trigger is Tripped: T/F Custom Event of Default Allows the modeler to customize a default state on a period-by-period bases and input it directly None Entered for each period of CF Event of Default state is entered for each period: T/F

4 A mechanism for hedging risk by swapping a party s exposure to a counterparty Interest Rate Fixed-to-Floating Basis Rate-to-Rate Credit Default F/X PMB implements fixed-for-floating IR swap usually entail a cost in the deal for the risk benefit received paid prior to fees PMB on Liability Side IR Swap Structure Parameters Swap Active: Y/N Swap Rate In: Vector Swap Rate Out: Vector Waterfall/Cash Flow Cash Flow Sections on CF Sheet Swap Cash Flows Structure: notional/rate in/cf in/rate out/cf out/swap Net (in out)/cf available = CF from Assets + Net A mechanism for placing, holding and releasing cash in a transaction Can provide liquidity protection and/or credit enhancement depending on location in the waterfall In the BOTE analysis funding from XS was distinguished from a closing-funded reserve for credit measurement In modeling, funding at the beginning of the transaction just changes the initial state (to which operational XS may be added) for CF analysis Can be funded to a minimum of a fixed percent of PMB on Liability Side Reserve Account Reserve Active: Y/N (for each liability) % of initial collateral principal PMB Assumes the Reserve funded at closing How would PMB be modified if reserve were not fully funded at closing? If the reserve account goes below the %, then XS is tapped Reserve is a fixed amount in PMB amortizing is not modeled How would you add an amortizing reserve, instead? Assumption: Only senior tranche has access to reserve Waterfall/Cash Flow liabilities or a fixed dollar amount

5 PMB on Liability Side Reserve Account Waterfall/Cash Flow Cash Flow Sections on CF Sheet Period Reserve Account Structure: minimum/beginning/withdrawals/reimbursements/ ending balance/cash remaining for each period Reimbursements are made to the account if it is below minimums and the covered tranches are not paid off A bug in PMB? (missing a -BI? in cell BJ?) Senior Interest/Principal CF Structure: augment to show unpaid covered by reserve and remaining still unpaid This amount now constitutes withdrawals XS Released after any required application to Senior Principal Senior Principal Due when trigger breached another PMB bug? 1.17 A Note About Ratings We have everything we need to start to perform primitive CF-based ratings analysis We can run PMB to see if the deal performs on any given scenario Alternatively, we can look at a variety of scenarios and judge as to whether the deal performs as expected, or and more important if & when it doesn t 1.18 A Note About Ratings Questions? S&P and (to some extent) Fitch perform ratings analysis using stress tests Here, a variety of scenarios are run to judge deal performance under adverse condition Alternatively, one could generate scenarios under a modeled variation of likely future states and in doing so generate an ensemble of outcomes with statistical properties this is the Moody s approach This is what we will look at next: R&R Chapter Midterm Review