1 / 30

Pricing Structured Finance, Project Finance and Credit Enhancement

Pricing Structured Finance, Project Finance and Credit Enhancement. Paul R. Hussian, FCAS Seminar on Reinsurance June 15, 2000. Transaction Examples. Trade Receivables Debt pools: Bonds (CBO), Bank Loans (CLO) Entertainment: Film Receivables

booth
Download Presentation

Pricing Structured Finance, Project Finance and Credit Enhancement

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Pricing Structured Finance, Project Financeand Credit Enhancement Paul R. Hussian, FCAS Seminar on Reinsurance June 15, 2000

  2. Transaction Examples • Trade Receivables • Debt pools: Bonds (CBO), Bank Loans (CLO) • Entertainment: Film Receivables • Real estate finance: Commercial and residential mortgages (MBS) • ...

  3. Corporate Debt Ratings

  4. Structure Structure 1 Structure 2

  5. Two Pricing Perspectives • Actuarial/Insurance • premium • Capital Markets • yield spread: over Treasuries/LIBOR

  6. Actuarial/Insurance Pricing • Identify assets/cash flows • Identify risk(s) • Gather data • Build cash flow model • Run cash flows through deal structure • Determine Premium, Profit, ROE

  7. Assets / Cash Flows • Receivables Collection cycle • CBO/CLO Pools of debt (bonds, bank loans) • Entertainment Film receipts • Real estate Commercial/residential property

  8. Risks (Quantitative) • Receivables Credit defaults, price/volume • CBO/CLO Bond/loan defaults, interest rates • Entertainment Film performance • Real estate Property value, rent income • All transactions Correlation to economy

  9. Data Sources • Commodities Commodities futures exchange, Bloomberg, company • CBO/CLO Moody’s, S&P, sponsoring bank/company • Entertainment MPAA, company • Real estate Company, FHA, FDIC, private industry study • All transactions Offering Memorandum

  10. Cash Flow Modeling – Common Challenges • Company’s business model / economics of industry • Stochastic modeling / simulation • mean, standard deviation, distribution of key variable(s) • Scenario testing • stress tests; where is deal’s “break point”? • effect of recession • Correlations • between variables • between assets/cash flows • to economy (cyclical, counter-cyclical, recession-proof)

  11. Receivables - Cash Flows • Credit defaults on receivables • historical ratio: defaults  receivables • strength of obligors • Price/volume of commodity being produced • range of price fluctuation • effect of recession on price, volume • obligor concentration risk

  12. Sample Receivables Loss Data Increasing Loss Trend Historically 3%, volatile Historically 3%, stable

  13. Receivables – Sample Average Monthly Price Data (Heavy Crude Oil)

  14. CBO/CLO – Cash Flows(Default Rates) • Default Rate (frequency) = % of bonds/loans defaulting • Annual, multi-year • Moody’s/S&P credit ratings of bonds/loans in portfolio (Aaa, Aa1, …) • Correlation between bonds/loans • Diversity Score: translate portfolio into homogeneous, independent debt securities • Binomial distribution

  15. CBO/CLO – Cash Flows (Severity) • Severity = 1 - Recovery Rate • Recovery Rate = post-default market value  par value • Moody’s/S&P credit ratings of portfolio notes (Aaa, Aa1, …) • Normal, Lognormal distribution • Correlation between frequency, severity • Loss rate = Default rate x Severity

  16. One-Year Default Rates by Year and Rating

  17. Average Cumulative Default Rates by Rating

  18. CBO/CLO –Historical Recovery Rates 1977-98

  19. CBO/CLO – Moody’s Diversity Score • Avg default rate = p, Diversity score = n, Recovery rate = r • p = weighted avg of individual bond default rates • n selected to equate loss variance • Decreasing n increasing volatility & correlation • binomial C.V. = • n depends on industry concentration • S&P method: increase p with industry concentration, assume independence

  20. CBO/CLO - Example

  21. Entertainment – Cash Flows (Film Co.) • Coverage ratio = film revenue  production cost • mean • standard deviation • Box office, licensing, pay-per-view, international • Film revenue stream • Correlation between films

  22. Real Estate – Cash Flows • Occupancy rates • Average rents • Capital structure (debt, equity) • Property value • cash flow discount rate • Mortgages unrated, use industry data (FHA, FDIC) • Strong correlation to economy

  23. Modeling Deal Structure • Tranched (layered) vs Syndicated (pari passu) securities • Cash flow waterfall • Equity, subordination structure • Early amortization triggers • Indemnification provisions • Floating rates • Impact on insurer’s profit & risk

  24. Capital Markets Pricing • Premium vs. yield spread between unwrapped notes and insurer credit rating • Insurance vs. levered investment in unwrapped securities (insurer = investor)

  25. Current Spreads Over Treasuries (Financials)

  26. Example • 5-yr bond: par value = $100M insurer rating = Aa1 145 b.p. over T unwrapped notes = Ba3 415 b.p. over T insurer premium = (415 – 145) b.p. x $100M = $2.7M/yr present value = $10.1M

  27. Example

  28. Model Metrics • Debt service coverage ratios = cash flow / debt service • Balance sheet: equity, debt • % collateralization (value of collateral / full limits loss) • CBO collateral/CBO principal • loan/value (real estate, mortgages) • Default probability & Loss rate (principal, interest, premium) – compare to Moody’s ratings • Transaction break point • Insurer present value profit/(loss) • Relative risk/reward of tranches (IRR)

  29. CBO Example

  30. Model Output

More Related