Where can I get full documentation on a CDO and its tranches?
I work for a credit union that has nothing whatsoever to do with the mess going on in the housing market right now, thank goodness. (No, we aren't users of MERS.) As the person at the credit union most interested and knowledgeable about this topic, I have been asked to explain to our Senior Management exactly what went on with CDO's, in large part to help us better understand how the process can go wrong. While we understand generally what "senior" and "junior" positions mean, I thought it would be helpful to actually read the docs for some CDO REMIC sold by Citi, BoA et al that breaks it down. (For this example, a one that breaks a stream down by principal vs interest and periods of time would be helpful, e.g. Tranche A gets Interest years 1-2, Tranche B gets Principal years 1-3, etc.)
I considered starting with the SEC's Edgar database of filings but it is not certain to me that this will be the best source. I'm willing to read all the legal docs I need to but I really would like to be able to stand in front of an audience and explain from beginning to end with an example, who paid what to whom and what those buyers were expecting to get over time and the risk each should have known they were facing by purchasing that particular tranche of the CDO.
Judge Julie: I hope you think you are being helpful with your post. I submitted this question in the Investing section and anybody reading my subject would know immediately about what I was asking. This is a question that not a lot of people here can even answer so the subject was written intentionally to weed out those who cannot.
Mike: Thank you but I knew 99% of what you posted. I am asking, for example, if I l know a CMBS exists called CWALT 2005-56 issued by Countrywide, where can I see the actual prospectuses (is that a word?) and legal documents that detail who gets what? I presume that an offer to sell these securities could not have been made without going through the normal SEC processes. I want to track back through one of these and really understand it, to what degree I can through publicly available information.
- MikeLv 69 years agoFavorite Answer
Although most blame the credit crisis on CDOs, the majority of the problems were caused by Synthetic CDOs (side bets on the mortgages).
A standard CDO has three tranches, the senior tranche, the mezzanine tranche, and the equity tranche. Approximately 85% of the bonds issued are in the senior tranche which are normally rated AAA. The mezzanine tranche is still investment grade but usually rated in the mid or lower grades. The equity tranche is usually rated as non-investment grade.
The length of the interest payments and principle repayments are dependent on mortgages in the CDO. The interest payments are based on the amount of interest payable by the mortgages (minus management fees and reserves) and the rating of each tranche.
The following is an example:
The CDO contains mortgages that mature from 5 years to 30 year. Therefore principle repayment will occur at different times.
Average interest rate of the mortgages: 6.5%
Senior Tranche: 5.5%
Mezzanine Tranche: 7.0%
Equity Tranche: 9.0%
Management fee: 0.25%
Interest and principle repayments are first paid to the senior tranche, then the mezzanine trance, and finally the equity tranche. Normally it is expected that there will be some defaults in the equity tranche but very limited defaults can be paid out of the reserves but it is assumed that there will never be enough defaults (both in interest and principle) to ever cause underpayment in the senior tranche. This is accomplished by having the vast majority of mortgages being prime mortgages with a significant down payment and only a small minority as sub-prime and atl-a loans.
The problem started occurring when mortgage companies started selling too many sub-prime, alt-a, loans with little or no down. Investment banks started packaging up to 50% of a CDO with those type loans causing interest and principle repayment reductions in the senior tranche.
Although this caused a certain amount of problems for the AAA bond holders (maybe a 20% loss in interest and principle), the crisis wouldn't have occurred if it was only for the standard CDO.
The main problem was the Synthetic CDO which made up over 75% of the market and were usually much riskier than the standard CDO. A Synthetic CDO is made up of credit default swaps (but not the AAA tranche since it was assumed to be safe) and just points to different mortgages in other CDOs. Unfortunately many of these CDOs were pointing to mostly garbage causing losses of up to 90% in the AAA bonds.
It is easy to distinguish a Synthetic CDO from a standard CDO in that there is a "super senior tranche" (rated AAA) in a Synthetic CDO. As an example, Merrill Lynch sold $32 billion of super tranches for $6.7 billion and loaned the purchaser $4.7 billion to purchase them which only had to be repaid if the buyer made money.
The following are some articles that can help to explain CDOs and the problems.
- Judge JulieLv 79 years ago
CDO Collateralized Debt Obligation
CDO Collaboration Data Objects (Microsoft)
CDO Chief Development Officer (corporate title)
CDO Chief District Officer (Nepal)
CDO Command Duty Officer
CDO Central Dense Overcast (meteorology)
CDO Community Development Organization
CDO Community Dial Office
CDO Community Development Office
CDO Chromosome Deletion Outreach, Inc
CDO Care Delivery Organization (healthcare)
CDO Capital Defender Office
CDO Clergy Deployment Office(r)
CDO Central Dispatching Organization
CDO Communications Duty Officer
CDO Central Documentation Office
CDO Child Development Officer
CDO Civil Defense Office
CDO Chicago District Office
CDO Central Disbursing Officer
CDO Chief Disciplinary Officer (prisons)
CDO Customer Direct Order
CDO Coaxial Digital Output
CDO Commercial Development Office
CDO Change Design Order
CDO Construction Development/Design Office
CDO Community Development Organizer
CDO Classified Documents Officer
CDO Constrained Distortion Optimal
CDO Change Data Order
CDO Control Document Officer
CDO Community Development Outline
CDO Controlling DoD (Department of Defense) Office
CDO Callable Debt Obligation
Now which "CDO" are you referring to?
- bichoffLv 43 years ago
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