Structured Finance and the Financial Turmoil of 2007 2008

Originator creates pool of mezzanine tranches b of

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SOURCE: Adapted from: ECB (2008a), Criado and Van Rixtel (2007), Renault (2007), IMF (2006), Cousseran and Rahmouni (2005) and Tavakoli (2003). Originator: Creates pool of “mezzanine” tranches (“B”) of various RMBS (collateral asset pool) Special purpose vehicle (SPV): Creates and issues CDO tranches Investors: Buy (tranches of) CDO in the form of differently rated notes Cash Creation and sale of “tranched” CDO in the form of tranched notes Cash Credit enhancement (over- collateralization, insurance, etc.) Rating agencies Monolines Simplified structure : No separate servicer, trustee, underwriter and/or swap counterparty. Instead of RMBS, the underlying assets of CDOs basically can be anything, such as other asset-backed securities, bank loans (create CLOs), bonds (create CBOs), credit default swaps and even other CDOs and hybrid portfolios. Investors in “mezzanine” tranches (rated “B”) of various RMBS Cash Sale of “B” tranches of RMBS Sale of pool of “B” tranches of various RMBS Fees Fees Fees Fees BANCO DE ESPAÑA 27 DOCUMENTO OCASIONAL N.º 0808
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Figure 6: Example of “double layered securitization” process: Creation of CDOs that are based on residential mortgage-backed securities (RMBS) Mortgage pools (may include subprime mortgages) Creation of RMBS with the following tranches (securitization I): Portfolio of “mezzanine” (BBB) tranches of various RMBS Creation of CDO with the following tranches (securitization II): Pool A based RMBS: “Super-senior” (AAA) tranche (75%) - “Super-senior” (AAA) tranche - “Senior” (AA) tranche # Pool A of residential mortgages - “Mezzanine” (BBB) tranche - “Subordinated” (B) tranche - “Equity” unrated tranche Pool B based RMBS: “Mezzanine” (BBB) tranche RMBS, pool A - “Super-senior” (AAA) tranche - “Senior” (AA) tranche # “Mezzanine” (BBB) tranche RMBS, pool B Pool B of residential mortgages - “Mezzanine” (BBB) tranche - “Subordinated” (B) tranche “Mezzanine” (BBB) tranche RMBS, pool C “Senior” (AA) tranche (12%) - “Equity” unrated tranche Etc. Pool C based RMBS: - “Super-senior” (AAA) tranche “Mezzanine” (BBB) tranche (4%) - “Senior” (AA) tranche # Pool C of residential mortgages - “Mezzanine” (BBB) tranche - “Subordinated” (B) tranche “Subordinated” (B) tranche (4%) - “Equity” unrated tranche “Equity” unrated tranche (5%) Etc. Etc. SOURCE: Criado and Van Rixtel (2007) and Citigroup (2007). BANCO DE ESPAÑA 28 DOCUMENTO OCASIONAL N.º 0808
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BANCO DE ESPAÑA 29 DOCUMENTO OCASIONAL N.º 0808 Table 3: Relationship between structured CDOs and the subprime crisis 1 Types of CDOs based on various types of asset-backed securities (ABS) as collateral CDOs with “high grade” rated ABS as collateral CDOs with “mezzanine” rated ABS as collateral Specific collateral: - Subprime residential mortgage-backed securities (subprime RMBS) 50% 77% - Other residential mortgage-backed securities (RMBS) 25% 12% - CDOs 19% 6% - Other underlying collateral 6% 5% 100% 100% SOURCE: BIS (2008a), p.3.
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