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Holmes


Total Posts: 185
Joined: Dec 2004
 
Posted: 2006-10-27 12:09

Right, forgive my ignorance on this but I'd like to know more about this. I'm quite lost, and comments are welcome.

Newsflash!

Dealers race to complete CPDOs

Arrangers are racing to complete deals emulating ABN Amro's so-called CPDO (constant proportion debt obligation) structure. The Dutch bank has now sold over €1 billion of its index-based Surf deal, which has achieved triple-A ratings from both Standard & Poor's and Moody's despite paying a mouth-watering spread of 200 basis points over interbank rates.Merrill Lynch, Ixis CIB and Lehman Brothers are among those with deals in the works, while other banks thought to be looking at the space include Calyon, BNP Paribas, Morgan Stanley and SG. "We are working on concrete proposals for four or five deals with similar structures [to ABN Amro's deal] in terms of their leverage mechanism," says Mehdi Khéloufi-Trabaud, senior associate at Moody's in Paris. "And we have had conversations with many other banks on this topic."

Like a credit CPPI, the new breed of deals is referenced to a credit portfolio that can vary in size depending on its market value. However, unlike a CPPI, which usually has a principal-protected payout, a CPDO carries regular coupons like a conventional bond. The mechanism that allows the coupons to benefit from a triple-A rating is that leverage increases as spreads in the underlying collateral widen. By contrast, in a conventional CPPI, a fall in market value leads to a decrease in leverage. Once the CPDO has achieved sufficient returns to match the present value of its coupon and principal payments, the deal is unwound.

So far, all the CPDO deals completed have used credit indices, with the arranger rolling the port-folio from one series to the next.

Using rolling indices as the underlying reduces the risk of default in the portfolio and helps the structure achieve a triple-A rating. But there are several deals in the pipeline using bespoke portfolios. "We are looking at proposals for CPDO-type deals based on bespoke portfolios of corporates and asset-backed securities, says Olivier Toutain, senior analyst at Moody's in Paris. "But in those cases you need to have mechanisms in place to avoid as much as possible defaults.

Lehman Brothers is one firm that is taking a different approach to achieving liquidity in the underyling portfolio. Its Dynamic Participation Investment Return Obligations deal is structurally similar to ABN Amro's CPDO but it uses the bank's own money market securities fund as the underlying assets. "The collateral comprises triple-A money market funds offering daily liquidity with no charges for withdrawing liquidity early within any given period," says Dan Hersson, director and head of European credit hybrid trading in London. "They are open-ended investments with the highest possible rating."

Likewise Ixis CIB, while currently developing a deal based on corporate indices, is also considering independently managed transactions in future. Says Victoire Blazsin, structured credit marketer at Ixis: "We are also working on a more mid-term project, which is a managed CPDO extending the technology to different asset classes or accessing different positions - not only indices, but a more diversified portfolio of single names."

"

Yesterday, the story goes, the Credit indices tightened because a 'New!' structured product was printed that required selling it, alot. This and folk front-running this product. Hmmmm

This 'thing' seems to require infinite leverage to exist (the seller needs to pay the coupons and to do so they sell the index!!?!?).

But '

triple-A ratings from both Standard & Poor's and Moody's despite paying a mouth-watering spread of 200 basis points over interbank rates.'

 

and'

The mechanism that allows the coupons to benefit from a triple-A rating is that leverage increases as spreads in the underlying collateral widen

'

 

 


Cheng


Total Posts: 2864
Joined: Feb 2005
 
Posted: 2006-10-27 13:15
I have seen this structure a while ago, maybe I can help you.

The basic idea is really to sell protection on the index on 10 times, say, the notional you want to invest (100 mn for example). This means you sell prot on 1 bn index. Invest into the 7 yrs and you make around 35 bps now. This means you make 350 bps on your 100 mn invested of which you pay 200 bps to your customer and put the rest in a reserve account. Remember, you need some collateral because if spreads widen you might get hammered 10 times. If the index rolls you roll into the new one, at least there you will loose some MtM since the new index has a longer maturity than the old one.

I cannot say much about the rating but anything that pays 200 bps in the current environment cannot be AAA. Maybe from a credit risk perspective since default risk over a 6 months horizon is small, but for sure there is some market risk lurking in the corner.

HTH.

"We walk this earth / with fire in our hands / eye for an eye / we are Nemesis"

Holmes


Total Posts: 185
Joined: Dec 2004
 
Posted: 2006-10-27 16:21

Thanks Cheng

 

I asked some folk about this basically, in addition to Chengs comments I got that:

For this correlation desks leverage up when the market widens,(sell protection) but they should deleverage when it tightens (buy protection). Whether this increases/reduces volatility is a different story if you ask me.

Some hedge funbds are buying these things as collateral (hmmmmmm). But it seems its mostly retail cleints that are having a look.

As for the rating...nothing too clear.. it maybes boils down to 'Once the CPDO has achieved sufficient returns to match the present value of its coupon and principal payments, the deal is unwound.'

At which point I had to go and get lunch and the guys telling me this had to go and make more spreadsheets.

My instinct is that if more of these print, as the article suggests, the market will be crushed. Its bad enough without x10 leverage.

But if there is some sort of trigger (of which I have no idea what that could be) there could be a lot of volatility...I hope.

I can see somesort of scenario when some evil bastard hedge fund knows when the corr desk will have to buy and sell indices on these things, and thus front run them at every opportunity.


Cheng


Total Posts: 2864
Joined: Feb 2005
 
Posted: 2006-10-27 17:33

I can see somesort of scenario when some evil bastard hedge fund knows when the corr desk will have to buy and sell indices on these things, and thus front run them at every opportunity.

Same story with opposite sign in May 2005 when prop desks where front-running their HF clients in the tranche market. Can I interest you in a fabulous new business idea ? Evil Grin


"We walk this earth / with fire in our hands / eye for an eye / we are Nemesis"

KangaXX


Total Posts: 293
Joined: Mar 2005
 
Posted: 2006-10-27 21:24

The products are (currently) rated AAA. Im not at all positioned to really know about this so this might be bull, but I heard the product exploits S&P's ratings methodologies (like all structured credit products) which basically runs a monte carlo simulation and if the path of the simulation leads it to a place where there would be any loss whatsoever this counts as a "failed run". S&P then compare the number of failed runs to good runs to determine rating. IE, they do not distinguish between a 1 cents loss at maturity and total wipeout. This product stays alive because if the current coupon return is insufficient to ensure a 200bp coupon then leverage is increased up to a max leverage amount, so there are very few failed runs, but failure means total loss. (The max leverage is fixed in the 7-15x zone, and typically product starts max levered and delevers if it achieves sufficient returns so that current coupon more than covers L+200 by 1.x times, or whatever). If product hits like 10 points of NPV it liquidates, and I think the remaining GAP risk sticks with the issuer....Really pushed the index market tighter, and made the index trade rich... Things will get nasty one day, in x years, with all of this kind of crap out there

So in summary, they basically figured a way to sell 0-6.6% equity on IG (rolling index) and rate it AAA.


Bright, energetic people—usually quite young—have promised to perform miracles with “other people’s money” since time immemorial.

kr
Founding Member
NP Raider
Total Posts: 3561
Joined: Apr 2004
 
Posted: 2006-10-27 21:40

I'm not too close to this thing either, but I see it as an upside-down CPPI that exploits people's appetite for CMCDS thinking.  To be clear - in CPPI, if you have MTM losses through spread widening, your buffer is getting squashed and you take chips off the table i.e. lower the leverage.  Here, you use the 'CMCDS argument' that if spreads widen, you want to take more exposure, i.e. 'dollar-cost-averaging' your spreads.  In reality this means that you add chips when you lose. 

At the end of the day, you get paid for products like this, CDO^2, and LSS, by taking ratings volatility.  Let's say you are under BIS-type capital rules.  You book the thing as +HIGHbps running, AAA asset for capital.  You do not say 'this asset has a far higher probability of being BB in the future, as compared with GE bonds'.  I was having a chat about this with somebody writing a BIS presentation today, and came to the conclusion that it represents the new reg arb.


my bank got pwnd

Holmes


Total Posts: 185
Joined: Dec 2004
 
Posted: 2006-10-31 09:58

Thanks for the comments. They make sense

Attached File: BLP10636.pdf  = Surfin USAAAAAAAA

 


Holmes


Total Posts: 185
Joined: Dec 2004
 
Posted: 2006-11-15 10:37

Slight aside, but was reading a prospectus just now ona step-up versionof this.

Under   'Investment Rationale' they have, seriously,:

+ “Buy low, sell high” strategy in order to perform well in a volatile credit environment'


Cheng


Total Posts: 2864
Joined: Feb 2005
 
Posted: 2006-11-15 10:42
That is probably the reason why they take big margins for setting up a leveraged vanilla product...

"Faster than a bullet / Terrifying scream / Enraged and full of anger / He's half man and half machine"

Groper


Total Posts: 12
Joined: Dec 2005
 
Posted: 2006-11-17 08:47

ive spent a bit of time on this product but my favourite analogy so far is:

bet on black, red comes up, double up + bet black again, red comes up etc...eventually you reach the table limit (max leverage) and cant bet more. At that point you knock out with 10% of your principal returned.

agree with kr:

you are selling ratings vol.

if credit doesnt follow the SnP assumed path it will get crushed - static credit scenarios will result in downgrades of surf with the recent prints at even greater risk of downgrade

...im looking fwd to listening to the sales/ client call when it gets downgraded in a benign environment Blendertime

also, at current levels you cant build up enough OC to sustain the strategy

 

 

 

 


Cheng


Total Posts: 2864
Joined: Feb 2005
 
Posted: 2006-11-17 11:58
Some interesting comments from Deutsche. So far I haven't seen them in CPDOs.

Attached File: DB_CPDOs_Isthebarbeinglowered.pdf

"Faster than a bullet / Terrifying scream / Enraged and full of anger / He's half man and half machine"

cabron


Total Posts: 62
Joined: May 2006
 
Posted: 2006-11-19 19:23

heck, you could do a cppi and a cpdo and as spreads get tighter, the cpdo buys protection from the cppi and vice versa - save some transaction costs.

eventually everything will be crushed tighter with low vol?

great thread btw.


Martingale
NP House Mouse

Total Posts: 2643
Joined: Jun 2004
 
Posted: 2006-12-05 16:07

just saw moody's primer on these, hmm.. martingale strategy...hmm... but they are saying they assume the spread is mean reverting, I vaguely recall reading this

http://www.boguslavsky.net/fin/quant05.pps

so in power utility and mean reverting trade, optimal strategy is to keep your position proportional to weath process, does this relate to the cpdo stuff? I am asking this because people are saying tha cpdo has postive gamma, but I am not so sure about it...


KangaXX


Total Posts: 293
Joined: Mar 2005
 
Posted: 2006-12-05 20:47

CPDO trades like it has positive gamma. It doesnt actually have any gamma because it has no optionality (except for the gaprisk option).

You can follow a buy low sell high mean reverting strategy on anything, its just sometimes things go too low or too high and without actually owning the option ur fucked


Bright, energetic people—usually quite young—have promised to perform miracles with “other people’s money” since time immemorial.

Cheng


Total Posts: 2864
Joined: Feb 2005
 
Posted: 2006-12-12 17:24
Some more comments and analyses from Citi. Seems like this CPDO stuff is pretty robust when markets get tougher.

Attached File: Citi_CPDOs - The new best seller.pdf

"Faster than a bullet / Terrifying scream / Enraged and full of anger / He's half man and half machine"

crquant06


Total Posts: 1
Joined: Oct 2006
 
Posted: 2006-12-12 20:06

The attached is a great analysis of CPDO.

Attached File: UBS Research - CPDOs.pdf


Groper


Total Posts: 12
Joined: Dec 2005
 
Posted: 2006-12-18 03:35

cartoon courtesy of MS

 

Attached File: cpdo.pdf

 


Bachelier
Transparent Doppelgänger

Total Posts: 692
Joined: Dec 2005
 
Posted: 2006-12-19 15:48
Etienne's report is first rate. Had a long discussion with him. I'm done thinking about this thing, until the agencies come back with their revised methodology and ABN AMRO comes out with "CPDO-Plus 2007!" or whatever they will call it.

"Those who can make you believe absurdities can make you commit atrocities." Voltaire

rockstar


Total Posts: 3
Joined: Jan 2007
 
Posted: 2007-01-23 20:04
Cairn Capital is reportedly going to begin roadshowing the first managed CPDO ...

Anand


Total Posts: 5
Joined: Jan 2007
 
Posted: 2007-01-24 14:02
Hi,

I am a student of finance and am currently writing a termpaper on exotic structured products. As part of that, I intend to analyse the recent CPDO deal in some detail. The reports and discussion above has been quite helpful to me. I was hoping if someone could help me get the ABN-AMRO CPDO deal prospectus, or that of a similar deal by other banks. This would be useful for me to replicate a CPDO model.

Thanks a lot for your help!

Holmes


Total Posts: 185
Joined: Dec 2004
 
Posted: 2007-01-24 18:47

I believe I put the Surf link is above? I can't tell anymore: internet security at work. Apparently its pornographic/ dangerous. I thought that quite funny


Anand


Total Posts: 5
Joined: Jan 2007
 
Posted: 2007-01-24 18:54
The SURF pdf posted on this site is a Marketing ppt that ABN uses. I am looking for the prospectus with information on say the waterfall, leverage formula and say the effect of the index roll.
Quite a few people have mentoned having seen it, it would be very helpful if some one can mail it to me at anandpriyankagmailcom

Thanks!

rowdyroddypiper
NP Wrestling Champion

Total Posts: 1181
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Posted: 2007-01-25 01:35

If you can't figure out a basic model from the presentation posted then you don't have a shot of doing it from the OM.  First of all there is no waterfall in this deal (at least in the traditional sense of a structured deal) as there is only a single note issued.  It's a safe assumption that the Admin and the Leverage facility fee are senior to the note.  That should really be your only payouts. 

Read the presentation and see if you can create a model from there.  It contains everything you need to get the deal approximately right. 

 


We are awakened with the axe, night of the living dead at last

Anand


Total Posts: 5
Joined: Jan 2007
 
Posted: 2007-01-25 11:04

Thanks, I'll try that !

simonsays


Total Posts: 66
Joined: Jan 2006
 
Posted: 2007-01-26 07:56

Can anyone recommend papers on default contagion?  I've seen some recently by Duffie.  He appears to have the most common sense of anyone I've seen who writes on default risk.  Is there anything available on cascading effects/bounded rationality/belief heterogeneity?

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