Introducing the BAS CDO ROE barometers.
I. TRACKING ARBITRAGE OPPORTUNITIES
The visibility of CDOs has increased considerably over the past few years. Rated CDO notes are now found in the portfolio of virtually any fixed income manager buying structured product. CDO equity buyers, however, are a smaller crowd. As the economy has slowed, this market has become more saturated and it has become more difficult to find these buyers. Indeed, the current economic environment has created unusual circumstances within which to examine the CDO markets. The recent tragedies have disrupted the equity and debt markets and have had some muted effects on CDO pricing. In our opinion, investor perceptions of CDO equity closely correspond to those of the stock market, especially in times of uncertainty. For example, increased investor caution has always correlated with a higher entry threshold for both markets, as investors wait to buy until the economy improves. Of course, at this point the unhealthy economic environment has already been discounted in equity markets, whether in stocks or CDOs. The challenge for investors is to build an equity portfolio before lagging indicators of economic performance show conditions have already improved.
Arbitrage spreads--the main driver behind CDO issuance and equity performance--are at historically high levels due to the combined effects of a substantial spread widening in the underlying collateral markets and the relative stability of CDO liability spreads. Asset spreads have recently begun to level out, but remain nonetheless at historic wides, particularly against swaps. The three major drivers of this spread widening have been an acceleration in liquidity, an increase in credit risks and technically tight swap spreads. However, underlying collateral defaults are at their highest levels since the 1990-91 recession period, due to such interrelated factors as the recent economic downturn, the weak state of the corporate bond markets, and decreased investor confidence, all of which have been exacerbated by the events of Sept. 11.
When examining opportunities in the CDO markets, the high existing arbitrage opportunities must be viewed jointly with expectations of some defaults. Therefore, although arbitrage spreads are useful ex-ante indicators of issuance and investor demand, more meaningful is the return on equity (ROE) for the equity investors in a CDO. ROE will account for not only asset yields and liability costs, but also expected defaults, expenses and fees, and leverage. In this article, we introduce our CDO ROE barometers, which quantify the attractiveness of issuing and investing in CDOs at a given time. As generic barometers, they do not represent the economics of specific deals or sets of deals. Rather, the barometers are gauges of the economic incentives for investing in CDOs backed by different types of collateral (further explanation is provided in the methodology sections for each barometer). Our barometers (Exhibit 1) represent the hypothetical equity returns of four generic CDOs, each backed by different types of collateral: HY bonds, HY loans, IG corporate bonds, and structured products of various types (henceforth we will refer to this deal type as "multi-sector"). These barometers are updated weekly in our Structured Credit Strategy Weekly.
II. RELATIVE VALUE OPPORTUNITY
Exhibit 2 summarizes the various assumptions and relative value opportunities specific to each deal type for base case (the empirical average adjusted for a degree of manager outperformance) and stressed case default scenarios. In the current high-default environment, most investors' assumptions will fall somewhere between the base case and stressed case to account for high front-loaded defaults. Base case assumptions range from a 0.25% constant annual default rate (CADR) for IG corporates and multi-sector deals to a 2.0% CADR for HY bonds, while the stressed case scenarios assume a range between 1.0% CADR for multi-sector collateral and 4.0% CADR for HY bonds. Under base case assumptions, the barometers (readings are as of November 2, 2001) span from 38.8% for HY bond deals to 23.0% for multi-sector CDOs, and under the stressed case scenarios, the barometers range from 28.8% for HY bond deals to 15.5% for multi-sector CDOs. HY loan transactions, whose issuance has recently accelerated after a relative lull during the middle of the year, offer the second most attractive returns, with a base case IRR of 33.6% and a stressed case IRR of 29.1%. Multisector and IG corporate deals offer similar rates of return, with base cases of 23.0% and 27.6%, and stressed cases of 15.5% and 16.4%, respectively.
The primary driver behind the high ROEs implied by our barometers is the spread widening environment, which, in turn, has been driven by the following four factors:
* Liquidity risk. We are currently experiencing a spread contagion effect similar to what occurred in the fall of 1998 following the LTCM crisis. Much of the spread widening has occurred because of the premium required to compensate for a heightened probability of poor execution in the event of a sale and wider bid-ask spreads.
* Technically tight swap spreads. Ten-year swap spreads would be almost double their recent 60- to 70-bp trading range if not for three technical factors: convexity buying by mortgage bankers in the face of a rallying Treasury market producing prepayment pressure, heavier-than-anticipated Treasury supply, and exceptional carry. So long as these technical aberrations remain unchanged, we will continue to see historically attractive arbitrage opportunities, particularly in IG collateral where the aberrations account for such a large percentage of the arbitrage spread.
* Specific credit risk. Sectors such as telecom in HY and utilities in IG had experienced substantial spread widening before Sept. 11. Since then, it has been the directly affected industries such as airlines, insurance and travel-related sectors that have borne the brunt of spread widening.
* Systemic credit risk: The deteriorating economy has resulted in a general spread widening across sectors. Further, the events of Sept. 11 have caused investors to ponder how sectors not directly affected by the attacks might eventually be affected by differing homeland terrorist scenarios.
The first two factors make the arbitrage "real," whereas the last two factors signify higher default probabilities and thus detract from the arbitrage spread differential. So long as the first two factors remain a strong driver of wider arbitrage spreads, we believe the current environment is ideal for buying CDO equity. The duration of the fight against terrorism and the resiliency of the economy will determine how real the last two factors become. To the extent the economy rebounds in 2002, we do not expect the high defaults priced into spreads to occur. Moreover, a slight dislocation in the market--particularly one due to liquidity pressure--could make the arbitrage all the more attractive.
III. STRESSED CASE VS. BASE CASE DEFAULTS
The year 2001 has been plagued with historically high default rates, making it necessary for investors to adjust their default stress test scenarios. These scenarios take into account a degree of manager outperformance and ratings distributions, which are conservative vis-a-vis those implied by HY default indices. For both of these reasons, the base case default expectations in HY deals are much lower than the default indices. Better, proven managers clearly get more credit than managers with little track record and/or poor performance. As the rating distribution in HY CDOs is of much higher quality and has more even sector distributions than implied by the HY indices, base case default assumptions are significantly lower than empirical averages. Default scenarios also take into account the timing of defaults, which is particularly important in the current high default environment. For this reason, many investors assume high front-loaded defaults for a few years and then a fiat default rate. However, to keep all four barometers on an equal footing, we assume a constant annual default rate. Nevertheless, the stressed case scenario takes into account high front-loaded defaults by assuming a higher CADR than expected in the majority of the years.
Depending on collateral type and credit quality, most investors consider CADRs ranging from 0.25% to 1.0% for IG collateral and 1.5% to 4.0% for HY collateral. In the current spread-widening environment, our barometers indicate significantly higher indicative returns than the base case IRRs targeted by investors and managers (Exhibit 3). The HY Bond Barometer provides a perfect example, as even its current stressed case level of 28.8% exceeds the base case range of 20-25% targeted in the marketplace. Also demonstrative of this is the HY Loan Barometer, as its stressed case IRR stands about 10 percentage points above market objectives of 17-21%.
IG corporate and multi-sector deals also offer attractive rates of return, albeit at somewhat lower levels for each asset class. These smaller differences between the base case and stressed case returns and marketplace IRR objectives can be attributed to the smaller fluctuations in the spreads of IG collateral backing these deals. Still, the stressed case returns of 16.4% and 15.5% for IG corporate and multi-sector transactions, respectively, fall within the target range of 15-18% for both of these deal types. This month's average base case returns well surpass base case ranges, with that of IG corporate deals at 25.1% and multi-sector collateral at 22.7%. The barometers are intended to provide a range of ROE calculations under different CADR assumptions, which vary from period to period.
IV. THE METHODOLOGY FOR CONSTRUCTING THE BAROMETERS
The CDO barometers represent the returns for the equityholders of each type of deal using specific CADR, recovery rate, and expense assumptions.
The general formula for each barometer is as follows:
(CDO arbitrage spread--credit losses--fees--issuance expense) x leverage factor
In turn, the arbitrage spread is defined as follows:
Weighted average asset yield--liability cost
The above assumptions distinguish each barometer by its respective collateral type, and they will vary, either because of characteristics inherent in the assets themselves (such as credit quality or investment risk) or due to managerial preferences involved in the control of certain collateral types. Clearly, the use of broad-based asset indices does not reflect a particular manager's security selection or investment style, industry concentrations/avoidances or selective credit barbelling. The expenses and fees associated with a deal may also differ from our assumptions based on what a particular manager charges. While arbitrage CDOs reference actively managed portfolios, the use of an index for asset spreads does not account for a manager's ability to affect or enhance the transaction's performance through credit selection and the ability to trade.
Each theoretical CDO is based on general structural trends that we have observed in the recent primary markets. Over time, the liability structures of CDOs vary, based on supply and demand and general market trends. Movement in these asset spreads can affect the leverage factor of these structures, which is a large determinant of the deal's ROE. As asset spreads decline, the size of the equity tranche will likely increase because there is less excess interest cushion. By definition, as the equity increases, the leverage decreases, which results in a lower ROE. However, despite varying asset spreads and market trends, we maintain constant leverage factors and capital structures for each barometer. Although the capital structures tend to differ considerably between deals, leverage factors for each collateral type have remained somewhat constant in the past few years. One additional caveat is our computation of credit loss (default rate x (1--recovery rate)). In assuming a constant annual default rate, we do not account for declining principal balances, lost interest, and present value effects. However, these variables generally cancel out.
These are just a few factors to take into account, and we offer our methodologies for constructing each barometer for its specific collateral type below. Exhibits 4-7 display the inputs and key values of each barometer at significant dates as well as quarterly numbers for the first half of 2001.
V. HY BOND ROE BAROMETER
The HY Bond Barometer (Exhibit 4), readings are as of" November 2, 2001, provides a measure for the internal rate of return for the equity of a CDO backed primarily by HY corporate bonds. Our hypothetical HY bond portfolio includes an even mix of 50% BB and 50% B corporate bonds, with spreads quoted from the BAS HY Large Cap Index. On the liability side, we have assumed a basic structure of 70% AAA notes, 18% BBB notes mad 12% equity, with the funded liability prices reflective of general new issue CDO spreads in the primary markets at each point in time. Most market participants assume recovery rates of 40% for defaulted HY bonds, despite the recent aberration of low recovery values instigated by some recent telecom defaults. We use a base case default assumption of 2% CADR, which is lower than the 3-4% empirical CADR to account for manager outperformance and more conservative credit selection than implied by the default indices. The stressed case CADR is 4%, which should allow for front-loaded default scenarios which are expected in light of the recent troubles of the HY bond market.
As mentioned, our barometer assumes a conservative, even allocation to BB and B rated bonds. Many managers might seek to outperform and pick up asset yield by targeting a larger allocation to lower rated securities. Recently priced HY bond deals have targeted a 'B1/B+' weighted average rating, which is more aggressive and would achieve higher yields than our assumed collateral mix. Also, in many cases, managers allow for small buckets of a variety of assets, including loans and ABS, to achieve diversification or other specific objectives.
During the past year, HY bonds have almost consistently shown higher ROE barometer readings than the other asset classes, with the exception of a brief dip in February below those of multi-sector deals and HY loans (Exhibit 1). Starting at just above 30% at the beginning of 2001, the HY Bond Barometer dropped to 16.5% in the middle of February. The major driver of the HY Bond Barometer--rallying HY bond spreads--was caused by a combination of excess cash sitting on the sidelines and the Fed's rate cuts with expectations of more to follow. HY bond spreads shot up in mid-March, following the release of high default numbers and poor economic forecasts, therefore boosting the HY bond ROE up to 28.3% in the beginning of April. The barometer then followed a roller coaster ride, dropping below 25% in May before shooting up to 32.8% in June and leveling out around 25% in August and the beginning of September. After on Sept. 11, HY bond spreads widened dramatically, yet CDO pricing remained relatively stable. This disparity between CDO asset and liability spreads--coupled with relatively tight funding spreads--boosted the arbitrage spread up from 5.1% on Sept. 7 to 6.7% on Nov. 2, and drove up the barometer from 24.4% to 42.6% at its peak at the end of September. At Nov. 2, the barometer stood at 38.8%, its third-highest level of the year.
VI. HY LOAN ROE BAROMETER
Our hypothetical HY Loan Barometer (Exhibit 5), readings are as of November 2, 2001, assumes a fairly conservative 100% allocation to BB/BB- rated institutional loans, referencing S&P's Portfolio Management Data BB/BB- Index. While most CLO managers will include lower rated loans and bonds and assume a 2% general base case CADR, we account for our relatively less aggressive collateral pool by assuming a slightly lower default rate of 1.5%. Further, as compared to HY bond CDOs, CLOs tend to have more cushion in their performance tests and allow for more trading flexibility due to the collateral's shorter average life. Our liabilities are characterized by a simple but typical capital structure, consisting of 74% AAA rated notes, 16% BBB notes and 10% equity, resulting in a 10x leverage factor. As HY lenders are senior to HY bondholders in the corporate capital structure, investors will generally assume a higher recovery rate of 70% for defaulted loans.
Most HY loan CDO managers will allocate to a more diverse portfolio, including some lower rated loans and some HY bonds. However, due to an extremely thin primary market for B rated loans, we have chosen to maintain a portfolio consisting solely of BB/BB- rated loans. Since Sept. 11, due to investor uncertainty and general economic troubles, there has been no visible issuance of B loan deals, making indicative data virtually impossible to obtain. Therefore, it has been necessary to assume our 100% BB/ BB- loan portfolio, and accordingly adjust our default assumptions to account for the higher rated collateral that is likely to summarily have a lower default rate.
The HY Loan ROE Barometer is fairly well correlated to that for HY bonds, although in a less volatile way. The HY Loan Barometer started off 2001 at just under 20%, and hovered between 15-20% until the beginning of August, when it briefly dipped to 13.5%, but rose back up to just south of 20%. Since Sept. 11, BB/BB-loan spreads have steadily increased as much as 150 bps wider than pre-attack levels, causing the HY loan IRR to rise from 19.6% to its Nov. 2 level of 33.6%. This ROE is about 14 percentage points higher than its 2001 pre-attack average of 19.5%, making HY loan CDO issuance currently appear much more attractive than during the first three quarters of 2001.
VII. IG CORPORATE ROE BAROMETER
Our IG Corporate ROE Barometer, readings are as of November 2, 2001, exhibits the IRR for a hypothetical CDO backed by IG corporate debt (Exhibit 6). We have chosen a collateral portfolio consisting of 95% BBB rated corporate bonds, with a conservative bucket of 5% BB rated corporates. As the allocation to BBs is so low relative to most deals and there is no allocation to CDS assumed, the mix is quite conservative. Even in the current high-default environment, many managers are bringing deals with portfolios containing around 15-20% HY bonds and/or significant allocations to CDS, which have higher spreads on whole.
Due to the smaller probability of defaults in the IG collateral pool, we assume a liability structure that is more leveraged than those of our other barometers, consisting of 90% AAA notes, 6% BBB notes and a 4% equity tranche. This smaller equity percentage results in a leverage factor of 25x, which is important in generating an attractive ROE. As IG corporate bonds have historically rarely defaulted, we assume a smaller base case default rate of 0.25%, coupled with the 40% recovery rate that is generally assumed for IG corporate bonds. Due to their relatively small subordinate classes, IG corporate transactions are sensitive to the timing and degree of defaults of collateral assets. Pre-attack, the 2001 YTD stressed case level (1.0% CADR) for our IG Corporate Barometer, readings are as of November 2, 2001, was 3.6% on average, whereas the base case level was about 15.0%. As of November 2, the stressed case level stood at 16.4%, versus the base case of 27.6%.
IG corporate IRRs wavered just above 15% throughout the first five months of 2001 before dropping to approximately 11% during June and July. The IRR was slowly increasing in August, but after September 11, it shot up with the other barometers. The pre-attack levels indicate a lack of a real arbitrage in this market, as both the base case and stressed case IRRs were significantly lower than those for the other three asset classes. As of Nov. 2, the IRR for this barometer stands at 27.6%, which is unusually high compared with the base case ROE objectives of 15-18% generally targeted by managers and investors (Exhibit 3). Furthermore, opportunities for higher returns exist if the manager allocates a portion of his portfolio to CDS, which generally offer significantly wider spreads than their cash equivalents.
VIII. MULTI-SECTOR CDO ROE BAROMETER
Due to the multitude of possible collateral combinations, these deals can vary significantly in asset mix as well as liability structure. Most multi-sector transactions will target a portfolio weighted toward one type of asset, generally ramping up portfolios dominated by ABS, RMBS, real estate, or CDOs. However, we have decided on a true multi-sector allocation by examining a diversified portfolio (Exhibit 7), readings are as of November 2, 2001. Specifically, our portfolio includes the following allocations: 20% BBB rated HEQ, 20% BBB rated CDO notes, and 10% each of BBB, BBB-, and BB rated CMBS, BBB private RMBS, BBB equipment, and BBB corporate paper. Multi-sector CDO managers will generally choose BBB rated assets, with small buckets of sub-investment grade paper, in order to obtain a higher yield without falling below an IG weighted average rating.
Due to the relative stability and higher ratings of structured finance assets, a more leveraged liability structure is more easily attainable in multi-sector CDOs than in CDOs containing other asset classes. Our capital structure contains 85% AAA notes, 10% BBB notes and 5% equity, producing a leverage factor of 20x, which is similar to that of our IG Corporate Barometer, readings are as of November 2, 2001. Due to the IG credit ratings and relative stability of these asset types, we have also chosen a base case assumption of 0.25% CADR, as well as a 50% recovery rate assumption that should correspond to the variety of assets represented in our portfolio.
The multi-sector CDO IRR has remained the most stable, lingering at just above 20% for the first half of 2001 and dropping to approximately 17-18% in June through August. The relative stability of structured product spreads drove the lack of movement in the barometer during the first part of the year. However, after Sept. 11, these spreads experienced some widening, albeit more moderately than that of other asset types. The barometer shot up to 23.1% from its pre-attack level of 16.9%, and has remained in the 22-23% range throughout the past month. As of Nov. 2, it was 23.0%, which is its third highest level year to date, but also the lowest level of all four of our ROE barometers.
LANG GIBSON is responsible for the research and strategy group for Structured Credit Products (SCP), whose product areas include credit derivatives, synthetic CDOs and cash CDOs. He writes and publishes the only extensive credit derivative/CDO weekly in the industry as well as numerous topical and primer reports covering SCP's three product areas. Prior to Bane of America Securities, Lang was the structured product strategist at First Union Securities. Prior to joining First Union in January, 1999, Lang brought eight additional years of structured product research and risk management advisory, experience from Goldman Sachs, J.P. Morgan and Ferrell Capital Management. In addition to firm research, Lang has published numerous articles and chapters in well-known trade journals and Frank Fabozzi publications. Lang holds an M.B.A. in Finance from the NYU Stern School of Business and a B.A. from the University of Virginia.
ERIN McCUTCHEON is a member of the Structured Credit Products (SCP) Research team at Bane of America Securities, where she tracks the CDO markets and contributes to the writing of their weekly credit derivative strategy report. She has been a member of SCP since September 2000, and has gained experience on the marketing, structuring, and research desks. Erin graduated cum laude from the University of Pennsylvania, where she obtained a B.A. in Economics.
Exhibit 2. CDO ROE Barometer (as of November 2, 2001) (Percent) ROE Barometer HY Bond (a) HY Loan (b) Current Week Base Case 38.8 33.6 Stressed Case 28.8 29.1 One-Month Average Base Case 38.5 29.2 Stressed Case 28.5 24.7 2001 Average Pre-Attacks Base Case 24.4 18.0 Stressed Case 14.4 13.6 Arbitrage Spread (Current Week) 6.71 4.66 Funding Mix AAA Notes 70.0 74.0 BBB Notes 18.0 16.0 Equity 12.0 10.0 Assumptions CADR-Base Case 2.00 1.50 CADR-Stressed Case 4.00 3.00 Recovery Rate 0.40 0.70 Ongoing Annual Fees 0.60 0.60 Amortiz. Issuance Exp. 0.25 0.25 ROE Barometer IG Corporate (c) Multi-Sector (d) Current Week Base Case 27.6 23.0 Stressed Case 16.4 15.5 One-Month Average Base Case 25.1 22.7 Stressed Case 13.9 15.2 2001 Average Pre-Attacks Base Case 14.9 19.5 Stressed Case 3.6 12.0 Arbitrage Spread (Current Week) 1.89 2.01 Funding Mix AAA Notes 90.0 85.0 BBB Notes 6.0 10.0 Equity 4.0 5.0 Assumptions CADR-Base Case 0.25 0.25 CADR-Stressed Case 1.00 1.00 Recovery Rate 0.40 0.50 Ongoing Annual Fees 0.40 0.50 Amortiz. Issuance Exp. 0.23 0.23 (a) 50% BB and 50% B HY bonds (BAS Large Cap Index). (b) 100% BB/BB- institutional loans (S&P/Portfolio Management Data). (c) 95% BBB corporates and 5% BB corporates (BAS Broad Market Index & Large Cap Index). d 20% BBB HEQ, 10% BBB Equipment, 20% BBB CDOs, 10% BBB CMBS, 10% BBB- CMBS, 10% BB CMBS, 10% BBB RMBS, 10% BBB Corporates. Source: Banc of America Securities LLC. Exhibit 3. Base Case CDO ROE Objectives Type Low High High Yield 20% 25% Loan 17% 21% Investment Grade 15% 18% Multi-Sector 15% 18% Source: Banc of America Securities LLC. Exhibit 4. HY Bond ROE Barometer--YTD 2001 (as of Nov. 2) (%) Weight 11/2/01 9/7/01 Assets BAS BB HY Spread Index 50% 5.32 4.42 BAS B HY Spread Index 50% 9.81 7.45 Swap Spread 0.67 0.79 BB/B Spread to LIBOR 6.90 5.15 Swap Rate 5.03 5.57 BB/B Asset Yield 11.93 10.72 Liabilities AAA LIBOR Spread (bps) 70.0% 0.47 0.45 BBB LIBOR Spread 18.0% 2.55 2.20 Equity (leverage factor=8.33) 12.0% AAA Cost 70.0% 5.50 6.02 BBB Cost 18.0% 7.58 7.77 Liability Cost 5.21 5.61 Arbitrage Spread 6.71 5.10 Recovery Rate 40% Base Case Default Scenario (%) 2.0 Credit Loss 1.20 1.20 1.20 Ongoing Mgt & Trustee Fees 0.60 0.60 0.60 Amortized Issuance Expense 0.25 0.25 0.25 BAS HY CBO ROE Index 38.8 25.4 3Q 01 (Pre- WTC Attack) 2Q 01 1Q 01 Assets BAS BB HY Spread Index 4.17 3.77 3.83 BAS B HY Spread Index 7.83 8.13 7.48 Swap Spread 0.84 0.82 0.91 BB/B Spread to LIBOR 5.15 5.12 4.74 Swap Rate 5.92 6.09 5.94 BB/B Asset Yield 11.07 11.21 10.68 Liabilities AAA LIBOR Spread (bps) 0.46 0.47 0.48 BBB LIBOR Spread 2.17 2.18 2.31 Equity (leverage factor=8.33) AAA Cost 6.38 6.56 6.42 BBB Cost 8.09 8.27 8.25 Liability Cost 5.92 6.08 5.98 Arbitrage Spread 5.15 5.13 4.70 Recovery Rate Base Case Default Scenario (%) Credit Loss 1.20 1.20 1.20 Ongoing Mgt & Trustee Fees 0.60 0.60 0.60 Amortized Issuance Expense 0.25 0.25 0.25 BAS HY CBO ROE Index 25.9 25.7 22.1 Source: Banc of America Securities LLC. Exhibit 5. HY Loan ROE Barometer--YTD 2001 (as of Nov. 2) (%) Weight 11/2/01 9/7/01 Assets PMD BB/BB- Inst Spread (to LIBOR) 100% 4.86 3.35 Swap Rate 5.03 5.57 BB/BB- Asset Yield 9.89 8.92 Liabilities AAA LIBOR Spread (bps) 74.0% 0.43 0.42 BBB LIBOR Spread 16.0% 2.40 2.10 Equity (leverage factor=10) 10.0% AAA Cost 74.0% 5.46 5.99 BBB Cost 16.0% 7.43 7.67 Liability Cost 5.23 5.66 Arbitrage Spread (%) 4.66 3.26 Recovery Rate 70% Base Case Default Scenario (%) 1.5 Credit Loss 0.45 0.45 0.45 Ongoing Mgt & Trustee Fees 0.60 0.60 0.60 Amortized Issuance Expense 0.25 0.25 0.25 BAS CLO ROE Index 33.6 19.6 3Q 01 (Pre- WTC Attack) 2Q 01 1Q 01 Assets PMD BB/BB- Inst Spread (to LIBOR) 3.13 3.13 3.26 Swap Rate 5.79 6.22 5.85 BB/BB- Asset Yield 8.92 9.35 9.12 Liabilities AAA LIBOR Spread (bps) 0.42 0.46 0.49 BBB LIBOR Spread 2.09 2.15 2.25 Equity (leverage factor=10) AAA Cost 6.21 6.68 6.34 BBB Cost 7.88 8.36 8.10 Liability Cost 5.86 6.28 5.99 Arbitrage Spread (%) 3.06 3.07 3.13 Recovery Rate Base Case Default Scenario (%) Credit Loss 0.45 0.45 0.45 Ongoing Mgt & Trustee Fees 0.60 0.60 0.60 Amortized Issuance Expense 0.25 0.25 0.25 BAS CLO ROE Index 17.6 17.7 18.3 Source: Banc of America Securities LLC. Exhibit 6. IG Corporate ROE Barometer--YTD 2001 (as of Nov. 2) (%) Weight 11/2/01 9/7/01 Assets BBB Corp Spreads 95% 2.82 2.36 BB Corp Spreads 5% 5.32 4.42 Swap Spread 0.67 0.79 BBB/BB Spread to LIBOR 2.28 1.68 Swap Rate 5.03 5.57 BBB/BB Asset Yield 7.31 7.25 Liabilities AAA LIBOR Spread (bps) 90.0% 0.48 0.44 BBB LIBOR Spread 6.0% 2.65 2.35 Equity (leverage factor=25) 4.0% AAA Cost 90.0% 5.51 6.01 BBB Cost 6.0% 7.68 7.92 Liability Cost 5.42 5.88 Arbitrage Spread (%) 1.89 1.36 Recovery Rate 40% Base Case Default Scenario (%) 0.25 Credit Loss 0.15 0.15 0.15 Ongoing Mgt & Trustee Fees 0.40 0.40 0.40 Amortized Issuance Expense 0.23 0.23 0.23 BAS IG CBO ROE Index 27.6 14.5 3Q 01 (Pre- WTC Attack) 2Q 01 1Q 01 Assets BBB Corp Spreads 2.34 2.45 2.66 BB Corp Spreads 4.26 3.79 3.83 Swap Spread 0.84 0.82 0.91 BBB/BB Spread to LIBOR 1.59 1.69 1.81 Swap Rate 5.93 6.09 5.94 BBB/BB Asset Yield 7.52 7.78 7.75 Liabilities AAA LIBOR Spread (bps) 0.45 0.47 0.47 BBB LIBOR Spread 2.49 2.65 2.60 Equity (leverage factor=25) AAA Cost 6.38 6.56 6.41 BBB Cost 8.41 8.73 8.54 Liability Cost 6.25 6.43 6.28 Arbitrage Spread (%) 1.27 1.35 1.47 Recovery Rate Base Case Default Scenario (%) Credit Loss 0.15 0.15 0.15 Ongoing Mgt & Trustee Fees 0.40 0.40 0.40 Amortized Issuance Expense 0.23 0.23 0.23 BAS IG CBO ROE Index 12.3 14.3 17.2 Source: Banc of America Securities LLC. Exhibit 7. Multi-Sector CDO ROE Barometer--YTD 2001 (as of Nov. 2) (%) Weight 11/2/01 9/7/01 Assets BBB HEQ LIBOR spread) 20% 2.50 2.05 BBB CDOs (to LIBOR) 20% 2.55 2.20 BBB CMBS (10yr) 10% 2.24 2.15 BB CMBS (10yr) 10% 5.45 5.15 BBB Corporates (10yr) 10% 2.82 2.36 BBB- CMBS (10yr) 10% 2.59 2.60 BBB Private RMBS (7yr) 10% 2.80 2.90 BBB Equipment (3 yr) 10% 2.57 2.05 10 yr Swap Rate 5.03 5.57 Asset Yield 7.47 7.67 Liabilities AAA LIBOR Spread (bps) 85.0% 0.50 0.48 BBB LIBOR Spread 10.0% 2.60 2.40 Equity (leverage factor=20) 5.0% AAA Cost 85.0% 5.53 6.05 BBB Cost 10.0% 7.63 7.97 Liability Cost 5.46 5.94 Arbitrage Spread 2.01 1.73 Recovery Rate 50% Base Case Default Scenario (%) 0.25 Credit Loss 0.13 0.13 0.13 Ongoing Mgt & Trustee Fees 0.50 0.50 0.50 Amortized Issuance Expense 0.23 0.23 0.23 BAS Multi-Sector CDO ROE Index 23.0 17.5 3Q 01 (Pre- WTC Attack) 2Q 01 1Q 01 Assets BBB HEQ LIBOR spread) 2.15 2.43 2.50 BBB CDOs (to LIBOR) 2.07 2.18 2.31 BBB CMBS (10yr) 2.15 2.18 2.28 BB CMBS (10yr) 5.15 5.24 5.34 BBB Corporates (10yr) 2.34 2.45 2.66 BBB- CMBS (10yr) 2.57 2.59 2.80 BBB Private RMBS (7yr) 2.90 3.04 3.11 BBB Equipment (3 yr) 2.08 2.00 1.93 10 yr Swap Rate 5.93 6.09 5.94 Asset Yield 7.99 8.27 8.18 Liabilities AAA LIBOR Spread (bps) 0.47 0.48 0.49 BBB LIBOR Spread 2.37 2.23 2.25 Equity (leverage factor=20) AAA Cost 6.40 6.57 6.43 BBB Cost 8.29 8.32 8.19 Liability Cost 6.27 8.27 6.29 Arbitrage Spread 1.72 1.85 1.90 Recovery Rate Base Case Default Scenario (%) Credit Loss 0.13 0.13 0.13 Ongoing Mgt & Trustee Fees 0.50 0.50 0.50 Amortized Issuance Expense 0.23 0.23 0.23 BAS Multi-Sector CDO ROE Index 17.2 20.0 20.8 Source: Banc of America Securities LLC.
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|Title Annotation:||collateralized debt obligations; return on equity|
|Publication:||The Securitization Conduit|
|Date:||Mar 22, 2001|
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