Originate-to-distribute business model? trivial question

Cheng · Post by **Cheng** » Thu Mar 06, 2008 6:24 pm

polysena,

in time means that you carry the risk of the loans while you collect them. This is called warehousing. You don't issue all the loans that you need for your ABS at the same time, instead you need some time to do so. If some of the loans default in the meanwhile or the securitization market breaks down you are in trouble.

If you buy back an equity tranche you do that intentionally (for whatsoever reason). This means you know what risk you gonna take. This is completely different if you intent to sell some tranches and cannot do so.

polysena · Post by **polysena** » Thu Mar 06, 2008 7:12 pm

hmm.. so even in the originate-to-distribute an IB say may decide to buy an tranche of her own stuff to keep it... what would be the rationale (except for the obvious you believe you'd make money by doing this)- is that a part of "proprietary strategies"? (sorry my wording is awful because I am so much of an ignorant with all this..)

If you (for reasons i still do not get do not want to keep the stuff you are producing9 then the goal is really to have only pass like a train (and you are the cow) in your trading book ... And of course things can go bad... as you describe... this I had understood..

I am really trying to figure out the big IB banks strategies....with the CDO's of ABS where in some sense they wanted to distribute but quite often they bought some tranches themselves... in what business strategy is that something one would want to do that do you know Master Cheng?

doobs · Post by **doobs** » Thu Mar 06, 2008 7:23 pm

I remember how they priced those deals, and the folks that traded this had no idea about incomplete mkts and price bounds. Where is Ricciardi now?

ficsur · Post by **ficsur** » Fri Mar 07, 2008 12:58 am

polysena: you expect a single rationale where there are a lot of driver.

IBs recycle originated mess in papers that:

sell in sum for more than the origin (wherby equity might be marked for recycling in the next layer)

or make the origin tradeable in the first place

or get the origin off the balance sheet so provide leverage

or enable favorable accounting

or create additional business with the producer of the origin

or offer a custom risk for a hedge fund

...

polysena · Post by **polysena** » Fri Mar 07, 2008 7:10 am

Ficsur... .. I want to understand all these drivers.. where do I learn about each of these strategical goals?

ficsur · Post by **ficsur** » Fri Mar 07, 2008 8:07 am

Selling the tranches in sum for more than the origin implies an arbitrage and inside knowledge of checks used by the rating agency.

Similary a monoline insurance on some tranches creates value only if the insurance is mispriced.

Regulatory requirements are not the same globally arbitraging them offers value too.

It might be favorable to account by accrued interes for nuclear waste instead of using mark-to-market, so push it to an entity allowed to do so.

How would a hedge fund otherwise get an exposure to credit card deliquency ?

I would be suprised to see papers about the above as they are alchemy but work in an imperfect market utilizing "expert" knowledge.

Cheng · Post by **Cheng** » Fri Mar 07, 2008 8:43 am

The business strategy is always the same, making Dollar Bill . You won't find much of that stuff written down. As fiscur said this involves expert knowledge and the value of an expert depends naturally on his knowledge, so why should you give it away.

polysena · Post by **polysena** » Fri Mar 07, 2008 9:42 am

Dear Cheng and Fiscur,

making money.. well even witout asking this question to start with.. I guess that I could have guessed ${L_SMILIES_SMILE}$

But then once you have gone by this obvious.. all is "vague"/ "expert".. secret...in this finance world ... put on top thick layers of jargon ( 34 terms for the same thing ..or not the same thing.. you'll never know.. wharehouse this sniff that.. etc..)

Somehow it is difficult to think straight in these or other related matters... journalists also do not get it right... so there is somehow nowhere to learn...

The origin of the question was that someone advocates also "vaguely and most probably not even knowing what it means themselves" including the "business purpose originate to distribute" as a "driver" for producing tranche ratings... ( I have a feeling that it is a weird proposal.. but to argue against it... I guess I must come up with better arguments as- {super (if I want to please my opponent) or crap (if I do not))

having to assess that.. the first question is.. what makes a "OTD -securitization program" so inherently different from a say "reg cap arbitrage program"... Is the purpose a important factor to analyse a securitization program?.. I have no idea..

For that I believed I best try to understand what OTD actually meant and entailed. I searched internet and everything I could to try to get a clearer picture.. not to avail...thus my initial question.

I somehow believed that say there are strategies, like with HFs- and that one can describe them say.. "in general" without any particular, not too the very details.. I would of course be interested in such kind of notes.. they exist for HFs.. why wouldn't there be something similar in the SF area..? So there are but, they are not "tellable" okay...

Anyhow thank you for your patience and informational "gifts" I do appreciate.

kr · Post by kr » Sat Mar 08, 2008 9:09 am

actually, originate-to-distribute goes back to well before ABS / CDO... for instance, JPM and others who had excellent access to the bank loan market, but decided to screw the relationship business and sell / hedge the loans via CDS, were o2d. The economics were pretty simple - you work on the deal docs and marketing, so you get paid an upfront fee. If you have that money in the pocket, why bother losing it while you hold the position?

And this is still the biggest problem area for banks, because o2d stopped working for their lev loan books where they took such 'attractive' upfronts from their mates in private equity, only to find that the loans themselves couldn't be sold into the market. Now they are roughly 300bn long across the banks in general, and as CLO is shut down, and credit cycle turn looks imminent so everybody's waiting to buy, the banks are completely stuck.

Clearly, regulators are now having a heart attack about o2d because it wasn't such an issue before, but now it is of such big magnitude that the impact is filtering into the real economy. I.e. failure to on-sell the loans means bank capital is stretched, means banks don't want to lend even if the central banks lower the short-term interest rates, means cenbanks are losing control of the economy... quite serious.

It used to be enough for the cenbanks to just review to quality of collateral i.e. special mention / NPL, to make sure it wasn't building up. But now liquidity is also their concern, and it's not that well understood. By opening up the discount window/TAF to more collateral, they haven't appeared to solve the problem, and maybe they've made it worse (i.e. introduced a new systemic risk). This same liquidity issue is what brought down the SIV market - i.e. all the above holds when 'regulator' is replaced by 'rating agency'.

So when you think about it, o2d is mostly about liquidity risks - seems pretty obvious actually. But how to originate using somebody else's liquidity, so that you are hedged? That is also part of the origination risk - that the product for sale was good enough for you to eat it, and let it 'season' on your books. I sort of think the problem goes back to the Glass-Steagall type issue, if your banks try to become investment banks then they may put their liquidity at risk against a type of project they weren't really intended to take on.

polysena · Post by **polysena** » Sat Mar 08, 2008 3:32 pm

Kr: very interesting and useful post. many thanks... I'll try to meditate on that a little, perhaps I shall progress in my thinking....