CDO Market Overview & Outlook CDOs in the Heartland Lang Gibson Director of Structured Credit Research March 25, 24
23 featured record volumes despite diminishing arbitrage Global CDO Growth: 1995-23 $ Billions 7 6 6 5 4 532 3 269 198 2 188 163 14 29 15 7 9 12 12 1 37 47 6 58 7 73 68 78 61 68 1995 1996 1997 1998 1999 2 21 22 23 Cash CDOs Synthetic CDOs Monthly Tailored IG Synthetic Volume Vs CDS Spreads - 23 6 14 Monthly notional volume ($Bns) 5 12 1 4 8 3 6 2 4 1 2 - - Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec Static arbitrage volume ($bns) CDS spreads (Trac-X NA Series 2) Trac-X NA, Series 2 (bps) 24 vs 23 CDO Volume Comparison (Jan-Feb) 1 Note: excludes index-based trades Cash CDOs 23 24 Growth Synthetic CDOs 2 23 24 Growth Total 4,564 8,325 82% Total 55,83 28,318 (49)% Multisector CBOs 3,8 6,115 13% Static Arbitrage 45,316 3,537 (92)% HY CLOs 1,145 1,299 13% Balance sheet 4,971 16,25 227% Other 412 911 121% Ind. Managed 4,796 8,531 78% 1 YTD 24 issuance through March 4 2 Synthetic issuance is often not reported (if at all) until quarter-end 2
Although CDO spreads finished the year tighter AAA Major CDO Subsector Spreads BBB Major CDO Subsector Spreads 1 5 9 8 7 6 5 4 3 3 Jul-1 Sep-1 Nov-1 Jan-2 Mar-2 May-2 Jul-2 Sep-2 Nov-2 Jan-3 Mar-3 May-3 Jul-3 Sep-3 Nov-3 Jan-4 Libor Spread (bps) HY CLO Tailored IG Synth. Multisector HY CLO Tailored IG Synth. Multisector 45 4 35 3 25 2 15 Jul-1 Sep-1 Nov-1 Jan-2 Mar-2 May-2 Jul-2 Sep-2 Nov-2 Jan-3 Mar-3 May-3 Jul-3 Sep-3 Nov-3 Libor Spread (bps) Jan-4 Primary Spreads in the Major CDO Subsectors HY Tailored IG Multi- CLO Synthetics sector AAA 45 7 51 AA 7 15 115 A 145 25 175 BBB 28 375 32 BB 725 N/A NA
Equity IRRs suggest further tightening ahead CDO Base Case ROE Barometers, as of March 19, 24 7 6 5 4 3 2 1 1/1 3/1 5/1 7/1 Base Case Equity IRR (%) 9/1 11/1 1/2 3/2 5/2 7/2 9/2 11/2 1/3 3/3 5/3 7/3 9/3 11/3 1/4 3/4 HY CBO (2.% CADR) Cash IG Corp (.25% CADR) HY CLO (1.5% CADR) Multisector (.5% CADR) CADR = Constant Annual Default Rate. 4
as does the growing pickup in CDOs to competing sectors across the capital structure AAA CDOs Versus Competing Sectors A CDOs vs. Same-Rated CMBS and Corporates 9 25 8 7 6 5 4 3 2 1 2 15 1 5 5 Jul-1 Sep-1 Nov-1 Jan-2 Mar-2 May-2 Jul-2 Sep-2 Nov-2 Jan-3 Mar-3 May-3 Jul-3 Sep-3 Nov-3 Jan-4 Jul-1 Sep-1 Nov-1 Jan-2 Mar-2 May-2 Jul-2 Sep-2 Nov-2 Jan-3 Mar-3 May-3 Jul-3 Sep-3 Nov-3 Jan-4 Libor Spread (bps) Libor Spread (bps) 1 yr CMBS 1yr CDO* 1yr CC 1yr RRB 7yr SL CMBS 1yr CDO* Corp BBB CDOs vs. Same-Rated CMBS, Corporates, and HEQ BB CDOs vs. Same-Rated CMBS and Corporates 9 8 7 6 5 4 3 2 1 Jul-1 Sep-1 Nov-1 Jan-2 Mar-2 May-2 Jul-2 Sep-2 Nov-2 Jan-3 Mar-3 May-3 Jul-3 Sep-3 Nov-3 Jan-4 Jul-1 Sep-1 Nov-1 Jan-2 Mar-2 May-2 Jul-2 Sep-2 Nov-2 Jan-3 Mar-3 May-3 Jul-3 Sep-3 Nov-3 Jan-4 Libor Spread (bps) 45 4 35 3 25 2 15 1 5 Libor Spread (bps) CMBS 1yr CDO* Corp HEL CMBS BB 1yr CDO* Corp BB/BB- Loan Note: CDO spread calculated as an average of the three major CDO sub-sectors ( HY CLO, IG synthetic, multi-sector)
While both actual and market implied defaults continue to fall across all sectors Leveraged loan default rate versus spreads: 5-Year Lookback US HY Spreads Versus Global HY Default Rate--23 BB/BB- loan spreads (bps) 5 45 4 35 3 25 2 15 1 5 - Dec-98 Mar-99 Jun-99 Sep-99 Dec-99 Mar- Jun- Sep- Dec- Mar-1 Jun-1 Sep-1 Dec-1 Mar-2 Jun-2 Sep-2 Dec-2 Mar-3 Jun-3 Sep-3 Dec-3 8% 7% 6% 5% 4% 3% 2% 1% % LCD 12-month loan issuer default rate Moody's Global HY 12-Month Default Rate 9% 8% 7% 6% 5% 4% 3% 2% 1% % J F M A M J J A S O N D 7 6 5 4 3 2 1 - BB/B HY Spread to Libor (bps) BB/BB- loan spreads (left) 12-mth leveraged loan default rate (right) Avg. HY bond spreads (right) Global HY Default Rate (left) Monthly IG Collateral and CDO Spreads Vs Defaults--23 Benchmark Mezzanine SF Spreads Vs Unemployment -- 23 S&P Global 12-Month IG Default Rate.5%.45%.4%.35%.3%.25%.2%.15%.1%.5%.% J F M A M J J A S O N D 14 12 1 8 6 4 2 - Spreads (bps) US unemployment rate (%) 6.6 6.4 6.2 6. 5.8 5.6 5.4 5.2 1/3 1/31 2/28 3/27 4/25 5/23 6/2 7/18 8/15 9/12 1/1 11/7 45 4 35 3 25 2 15 1 5 12/5 12/31 Spread to Libor (bps) AAA IG Synthetics (right) US IG CDS (right) Global IG Default Rate (left) 6 BBB HEQ ABS (right) BBB CMBS (right) US Unemployment rate (left)
The CDO pickup to competing assets grew to particularly wide levels recently BBB CDO* Pick-up to Competing Sectors and Collateral: Dec. 19 to Feb. 2 BBB CDO* Pick-up (bps) 25 23 21 19 17 15 13 11 9 7 5 12/19/23 1/2/24 1/16/24 1/3/24 2/13/24 BBB CMBS BBB Corp BBB HEQ BB/BB- Loans * CDO spread calculated as an average of the three major CDO sub-sectors ( HY CLO, IG synthetic, multi-sector) 7
Prompting us to upgrade CDO notes in most rating categories to High RV last month New Issue CDO Recommendation Matrix Published February 2, 24 IG Synthetics High Yield CLOs Multi-sector CBOs AAA High RV (+2) High RV (+1) Medium RV AA Medium RV High RV (+1) High RV (+1) A High RV (+1) High RV (+1) High RV (+1) BBB High RV (+1) Medium RV Medium RV (+1) Equity Low RV Low RV Low RV (-1) RV: Relative Value Note: (+1) / (-1) indicates a one-notch upgrade / downgrade in our recommendation since December 19, 23 8
However, a few CDO note categories have a disproportionately high level of downgrades Rating Share of Moody's 23-3 Global CDO Tranche Downgrades HY IG Synthetic HY Cash Synthetic Multisector Total CBOs Arbitrage CLOs IG Corporate Bal. Sheet CBOs Aaa 9% 9% 11% 2% 6% 7% 19% Aa 16% 13% 25% 17% 17% 18% 13% A 13% 9% 19% 11% 13% 21% 21% Baa 28% 26% 23% 33% 4% 18% 46% Ba 17% 2% 12% 19% 15% 15% 2% B 1% 12% 6% 1% 8% 15% % Caa 6% 8% 5% 7% 1% 5% % Ca 2% 4% % % % 1% % Total 1,78 541 219 88 86 73 48 9
Significant IG CDS spread widening over the past few months Instrinsic CDX.NA.IG Traded CDX.NA.IG 8 75 7 65 6 55 5 45 Jul-3 Aug-3 Sep-3 Oct-3 Nov-3 Dec-3 Jan-4 Feb-4 Mar-4 Note: Intrinsic CDX calculated as average mid-market spread of the index s 125 CDS names haircut by 7% (assumed value for the Restructuring credit event, which is not included in the index but is included in each CDS spread) 1
Has driven iboxx CDOs to historically cheap levels Historical iboxx Tranche Pricing Since Product Inception (Bid Side) 35 325 34 34 315 33 3 25 2 27 23 27 15 1 5 95 77 75 8 14 93 128 122 47 35 35 36 5 46 56 54 3 7% Tranche (BBB ) 7 1% Tranche (AAA) 1 15% Tranche (Super AAA) Oct. 2 (56 mid) Nov. 2 (52 mid) Jan 13 (48 mid) Jan. 26 (51 mid) Feb. 4 (58.5 mid) Feb 19 (56 mid) March 11 (64 mid) March 15 (63 mid) 11
Particularly in the senior classes Triple-A High Credit Spread Alternatives 14 12 122 1 8 8 7 6 4 54 45 4 37 31 25 2 7 1% iboxx CDO Junior MS CBO Junior HY CLO 1 15% iboxx CDO Senior HY CLO Senior MS CBO Equipment ABS CMBS Fltr HEQ ABS 12
Furthermore, iboxx CDO bid-offers have fallen significantly from launch levels Bid/Offer Spreads on iboxx CDO Tranches 14 12 1 9 8 6 4 2 7 5 3 3 6 4 33 25 16 16 18 2 8 8 12 12 1 3 7% Tranche (BBB ) 7 1% Tranche (AAA) Oct. 2 (56 mid) Nov. 2 (52 mid) Jan. 13 (48 mid) Jan. 27 (51 mid) Feb. 4 (58.5 mid) Mar 15 (63 mid) 1 15% Tranche (Jun. Super Sen.) 13
Relative value lies in senior and equity tranches Full iboxx CDO Capital Structure Pricing: March 15 (CDX Mid = 63 bps) Tranche Width Rating Bid Mid Offer Implied Correlation % - 3% * 3% NA 1,315 1,355 1,395 2.5% 3% - 7% 4% BBB- 33 36 39 *** 7% - 1% 3% AAA 122 131 14 19.% 1% - 15% 5% Super-AAA 54 59 64 24.% 15% - 3% 15% Super-AAA 13 17 21 33.% Weighted Average Funding Cost 61 64 68 * % - 3% equity tranche is actually quoted as an upfront payment (e.g., 4%) plus 5 bps running coupon. For calculating the funding cost here, we simply amortize the upfront payment over five years 14
iboxx CDO spreads are leveraged with respect to CDX index spreads 7% - 1% iboxx Tranche Sensitivity to CDX Average Spread 12 98 Change in CDO-level Spread 8 4-4 -8-66 -53-38 -2 22 46 71-12 2 bps 15 bps 1 bps 5 bps Base Case + 5 bps + 1 bps + 15 bps + 2 bps 15
and benefit from declining correlations 7% - 1% iboxx Tranche Sensitivity to CDX Average Correlations 12 Change in CDO-level Spread 8 4-4 -8-12 -86 12% Correl -65 9% Correl -42 6% Correl -2 3% Correl Base Case 17 + 3% Correl 32 + 6% Correl 45 + 9% Correl 56 + 12% Correl 16
Junior AAA STCDO-squared tranches offer the highest carry over a benign credit period 92.6% Super Senior Reference Portfolio 2% AA STCDOs & 8% AAA Structured Finance Bonds 1 Cashflows and Premium on Portfolio Swap Counterparty/ Arranging Dealer Default Protection 2 Swap Payment Issuer / Trust Notes Proceeds Notes Proceeds Notes Proceeds Notes Proceeds Notes Proceeds 3.% [Senior AAA] 2.% [Junior AAA].6% [AA].6% [A].6% [BBB] Eligible Securities 3.6% Equity 1. Cash flows and premium on the Reference Portfolio are transferred to Arranging Dealer. 2. The default swap premium paid by Dealer to the Issuer is in exchange for the credit protection provided. 3. The proceeds from the note issuance are invested in highly rated Eligible Securities. 17
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