1 / 39

Corporate-Backed Trust Securities

Similarities Credit exposure to the underlying issuer Credit decision based on public information Underlying issuer is the only payment source. Corporate-Backed Trust Securities. Secondary Market. XYZ bond. XYZ bond. Trust*. Retail / Institutional Investors.

ziarre
Download Presentation

Corporate-Backed Trust Securities

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. Similarities Credit exposure to the underlying issuer Credit decision based on public information Underlying issuer is the only payment source Corporate-Backed Trust Securities SecondaryMarket XYZ bond XYZ bond Trust* Retail / Institutional Investors Corporate-backed trust certificates Interest-only certificates • Differences • Recovery upon an event of default • Voting rights Institutional Investors Retail Investors * This is typical of a CorTS (CITI), CBTCS (LEH) or PPLUS (ML) transaction. In its most common form a corporate-backed trust security is a simple pass-through of the cash-flows of the underlying security and no credit risk is added to the structure 1

  2. Corporate-Backed Trust Securities Market Characteristics • The corporate-backed trust securities market emerged in 1999 and has grown significantly since that time • 260 transactions executed to date • Total market volume of over $12.4 billion • The most active participants are: • Citigroup (CorTS®) • Lehman Brothers (CBTCS) • Merrill Lynch (PPLUS) • Morgan Stanley (SATURNSM) • 5 other participants • Mostly sold through internal brokerage network but there is a significant amount sold by participants to third party dealers 2

  3. Direct holders No impact on the quality of credit Possible positive technical impact on the price due to scarcity Bonds continue to trade freely Impact of Cessation of Reporting • Repackaging investors • No impact on the quality of credit • Supply from trust termination(s) may have a negative impact on the price of the underlying securities and the resulting proceeds to investors • Repackaged securities stop trading Despite their similarities, a cessation of reporting has a very different and negative impact on a repackaged transaction 3

  4. CPI-Based Transactions Repackaging of directly-issued CPI bond CPI-linked repackaged security Directly-issued CPI bond Secondary Market SecondaryMarket XYZ CPI bond Monthly CPI-linked payment XYZ bond Semi-annual interest on XYZ bond Trust Swap Counterparty Trust XYZ Monthly CPI-linked payment MonthlyCPI-linked payment CPI-linked trust certificates Monthly CPI-linked payment CPI bond CPI-linked trust certificates Monthly CPI-linked payment Investors Investors Investors CPI-linked repackaged securities are very similar to directly-issued CPI-linked securities 4

  5. Comparison to Interest Rate Swaps Secondary Market Secondary Market XYZ fixed- rate bond XYZ fixed- rate bond Semi-annual fixed interest on XYZ bond Semi-annual fixed interest on XYZ bond Swap Counterparty Trust Swap Counterparty Trust Quarterly LIBOR-linked payment Monthly CPI-linked payment Quarterly LIBOR-linked payment Floating rate trust certificates Monthly CPI-linked payment CPI-linked trust certificates Investors Investors Like a floating rate repackaged security, a CPI-linked repackaged security reduces the investor’s fixed interest rate exposure 5

  6. 3MO Libor vs. CPI-Index Adjustment As of 09/13/04 Source: Citigroup and Bureau of Labor Statistics 3-month LIBOR and CPI levels have had similar trends since 1985, highlighting the similarity between the two indices 6

  7. CPI-Based Transactions • Since 1997, issuers including the US Treasury (TIPS) have issued bonds with principal and interest payments linked to the CPI • 15 TIPS issues for a total of approximately $211 billion • Greater liquidity in the TIPS market combined with the potential for rising inflation rates have strengthened both issuer and investor interest in CPI bonds • Corporate issuers may have limited interest in issuing CPI-linked debt • However, investors wish to obtain additional yield for credit risk in an inflation-protected format • Repackaged transactions can meet this desire CPI is an excellent example of a “synthetic” that should be included in the definition of “Asset-Backed Securities” 7

  8. Default Swaps and Credit Linked Notes CONFIDENTIAL DRAFT

  9. Default Swaps and Credit Linked Notes Table of Contents • 1. Repackaging Examples • Appendices • Appendix A - Credit Derivatives Market Overview • Appendix B - Introduction to Single-Name Credit Default Swaps and Credit Linked Notes • Appendix C - Introduction to the Dow Jones CDX.NA.IG

  10. 1. Repackagings Examples

  11. Example 1 - Single Bond • Investors assume credit exposure to a single bond of the underlying issuer • Underlying bond is the only payment source • Hundreds of existing public deals Secondary Market Single Bond Issued by XYZ Corp. Trust Institutional Investors Retail Investors In its most common form, a corporate-backed trust security is a simple pass-through of the cash-flows of a single underlying security and no credit risk is added to the structure

  12. Example 2 - Single BondRisk Transfer Via Default Swap (No Collateral) • Investors assume two separate credit risks. • The risk transfer with respect to the single bond is equivalent to “Example 1 -- Single Bond” • Default swap contract transfers no greater credit risk than the risk of a single bond that investors assumed in Example 1. • Difference compared with “Example 1 -- Single Bond”: investors also assume credit risk of the Swap Counterparty • Trust not needed -- Swap Counterparty could issue Credit Linked Note directly to investors (in which case no separate default swap contract is needed). Swap Counterparty Default Swap Contract on Single Bond Issued by XYZ Corp. Trust Trust Certificates Retail Investors

  13. Example 3 - Multiple Bonds of a Single Issuer • The risk transfer is equivalent to “Example 1 -- Single Bond”, except that investors assume risk with respect to multiple bonds of an issuer. • Underlying cash bonds are the only payment source • Existing public deals Secondary Market Multiple Bonds Issued by XYZ Corp. Trust Institutional Investors Retail Investors

  14. Example 4 - Multiple BondsRisk Transfer Via Default Swap (No Collateral) • The risk transfer with respect to the single bond is equivalent to “Example 3 -- Multiple Bonds of a Single Issuer” • Default swap contract transfers no greater credit risk than the risk of the bonds that investors assumed in Example 3. • Difference compared with “Example 3 -- Multiple Bonds of a Single Issuer”: investors also assume credit risk of the Swap Counterparty • Trust not needed -- Swap Counterparty could issue Credit Linked Note directly to investors (in which case no separate default swap contract is needed). Swap Counterparty Default Swap Contract on Multiple Bonds Issued by XYZ Corp. Trust Trust Certificates Retail Investors

  15. Example 5 - Multiple Bonds and Loans of a Single Issuer Risk Transfer Via Default Swap (No Collateral) • The risk transfer with respect tothe XYZ bonds is equivalent to “Example 3 -- Multiple Bonds of a Single Issuer”, except that loans entered into by the issuer are also included. • Default swap contract transfers (i) the risk of the bonds that investors assumed in Example 3, plus (ii) the risk of loans entered into by the issuer. • Difference compared with “Example 3 -- Multiple Bonds of a Single Issuer”: investors also assume credit risk of the Swap Counterparty • Trust not needed -- Swap Counterparty could issue Credit Linked Note directly to investors (in which case no separate default swap contract is needed). Swap Counterparty Default Swap Contract on Multiple Bonds and Loans of XYZ Corp. Trust Corporate-backed trust certificates Retail Investors

  16. Example 6 - Risk Transfer Via Default Swap (With Collateral) • Investors assume two separate credit risks (assuming de minimis exposure to Swap Counterparty). • Default swap contract may transfer no greater credit risk than the risk illustrated in Examples 1, 3 or 5. • Difference compared with Examples 2 and 4: investors assume credit risk of the Collateral. • In some cases, Swap Counterparty exposure must be considered. Swap Counterparty Default Swap Contract -- see Examples 1, 3 and 5 Trust $100 Issuing Entity Collateral Corporate-backed trust certificates $100 Retail Investors

  17. Upsizings • Only the size of the trust assets changes. • Certificates are fungible. • Requiring a new issuance imposes unnecessary transaction costs on investors and results in reduced liquidity of new issue. Upsizings of Transactions Should be Permitted

  18. Appendix A - Credit Derivatives Market Overview

  19. Credit Derivatives Market Overview Introduction • The Credit Derivatives market is one of the largest, fastest growing sectors of the financial industry • The Credit Derivatives market is forecasted to reach a size of approximately 4.8 trillion by the end of 2004(1) • Credit Default Swaps account for 67% of the Credit Derivatives market(2) • The default swap market presents the opportunity to: • increase returns generated from the credit markets • diversify and broaden the sources of credit investment opportunities • achieve more specialized exposure aligned with investment goals • create credit investments with attractive yields • Participation by a wide range of market participants ____________________ (1) BBA Credit Derivatives Report 2001/2002 (2) Fitch Ratings

  20. Credit Derivatives Market Size Composition of the Market as of End 2003 Market Overview ____________________ Source: Fitch Ratings ____________________ Source: ISDA

  21. Appendix B - Introduction to Credit Default Swaps and Credit Linked Notes

  22. Terms: Standard Credit Default Swap • Payment is contingent on triggering a Credit Event and satisfaction of the Conditions to Settlement with respect to a Reference Entity. Upon satisfaction of such requirement, Credit Protection Buyer selects Bonds or Loans of the Reference Entity to deliver to the Credit Protection Seller and Credit Protection Seller pays par for such Bonds or Loans. Premium Credit Protection Buyer Credit Protection Seller Contingent Payment • Physical Settlement. • No Credit Event occurs: payout=0. Reference Entity

  23. Example: Ford Default Swap [Premium bps] Credit Protection Buyer Credit Protection Seller Notional = $10 MM Contingent:Payment Upon occurrence of a Credit Event with respect to Ford, Credit Protection Buyer selects Bonds or Loans issued or guaranteed by Ford with a face amount equal to 10MM USD and Credit Protection Seller pays par even though Bonds may have a market value of 40%. Reference Entity Ford

  24. Credit Events • “Bankruptcy” - Reference Entity (Ford) goes bankrupt. • “Failure To Pay” - Reference Entity (Ford) fails to pay on a “Borrowed Money Obligation”.

  25. Deliverable Obligations: Bond or Loan Credit Protection Buyer delivers “Bonds Or Loans” issued by Reference Entity (Ford) or guaranteed by Reference Entity (Ford) that: - Not Subordinated to Reference Obligation - Not Contingent - Not Bearer - Maximum Maturity 30 Years - Standard Currency - Assignable/Consent Required Loan

  26. Introduction to Credit Linked Notes Credit Linked Notes (“CLNs”) Definition • A CLN is a fully collateralized credit default swap, in the form of a note issuance by a bankruptcy-remote issuer. • Why Collateralize? • Eliminates the protection buyer’s credit exposure to the individual investor • Offers investor credit exposure in a familiar bond-like form

  27. Introduction to Credit Linked Notes Credit Linked Notes (“CLNs”) vs. Bonds • Advantages of CLNs versus bonds: • maturity, coupon, and reference entity can be customized • flexible coupon (fixed, floating, monthly, quarterly, semiannually) • still maintains bond features and convenience • DTC settlement; separate CUSIP; Bloomberg listing; can be rated by the ratings agencies • CLN considerations: • liquidity may be less than a benchmark bond

  28. Introduction to Credit Linked Notes Credit Linked Note Basics • The investor is exposed to the Reference Entity and the underlying trust collateral (in the case of an SPV issuer) or Dealer (in the case of Dealer as issuer). • Upon the occurrence of a Credit Event with respect to the Reference Entity, the CLNs are redeemed and the protection Buyer (Dealer) delivers to investors the par amount of defaulted debt obligations of the Reference Entity to the total principal amount of CLNs. When a Credit Event occurs, investors in a credit linked note end up in the same position as they would have been if they had bought senior debt of the Reference Entity directly.

  29. Introduction to Credit Linked Notes Example CLN Structures CLNs: Special Purpose Vehicle as Issuer • For investors looking for a floating rate coupon…. Fixed rate “x” bps L + “y” bps Highly Rated Collateral Trust(SPV Issuer) Protection Buyer(Dealer) Default Protection $10mm Default $10mm L + x + y bps Investor

  30. Introduction to Credit Linked Notes Example CLN Structures CLNs: Special Purpose Vehicle as Issuer • …or a fixed rate coupon: Swap Counterparty L + x + y bps Fixed Rate Fixed rate “x” bps L + “y” bps Highly Rated Collateral Trust(SPV Issuer) Protection Buyer(Dealer) Default Protection $10mm Default $10mm Fixed Rate Investor

  31. Appendix C - Introduction to the Dow Jones CDX.NA.IG

  32. Introduction to the Dow Jones CDX.NA.IG Overview • The Dow Jones CDX.NA.IG is the New US Benchmarkfor tradable 5yr and 10yr index products • Liquidity • Proven liquidity track record from the market making group • Multiple market maker platform • Transparency • A transparent rules-based approach to portfolio construction • Standardization documentation • Globalization • The Dow Jones CDX.NA.IG is a pillar in the Dow Jones platform

  33. Key Features Introduction to the Dow Jones CDX.NA.IG Product Breadth Transparency Liquidity & Track Record • Track record in: • CDS flow market • Other credit indexes • Dow Jones Notes in Europe • The largest platform of leading market makers • Clear rules for portfolio construction • Pricing via Bloomberg • Standardization and multi-market maker platform to ensure transparency • Active participation of Dow Jones Ltd as Administrator • Unfunded or in CLN form • Tradable sector swaps Globalization Structure • Standardized documentation • 5 and 10 year maturities • No fees • Static portfolio of 125 diverse names • Dow Jones CDX.NA.IG is the New US Benchmark

  34. Benchmark Tradability Introduction to the Dow Jones CDX.NA.IG • Standardized CDS contracts • Sector trading • Financials • TMT • Energy • Industrials • Consumers

  35. Credit Event Example - Counterparty buys $100m Dow Jones CDX.NA.IG Exposure in Unfunded / CDS Form Introduction to the Dow Jones CDX.NA.IG • Credit Event • The fixed rate of the Dow Jones CDX.NA.IG is [70] basis points per annum quarterly • Market maker pays to counterparty [70] bps per annum quarterly on notional amount of $100m • A Credit Event occurs on Reference Entity, for example, in year 3 • Reference Entity weighting is 0.8% • Counterparty pays to market maker (0.008 x 100,000,000)= $800,000, and market maker delivers to counterparty $800,000 principal amount of Deliverable Obligations of the Reference Entity • Notional amount on which premium is paid reduces by 0.8% to $99,200,000 • Post Credit Event, counterparty receives premium of [70] bps on $99.2m until maturity • No Credit Event • The fixed rate of the Dow Jones CDX.NA.IG is [70] basis points per annum quarterly • Market maker pays to counterparty [70] bps per annum quarterly on notional amount of $100m • With no Credit Events, the counterparty will continue to receive premium on original notional amount until maturity

More Related