Super Senior CDO Tranches

[dimsdale]

Hi, can someone clarify these.  I believe in a synthetic CDO they were often retained by the dealer/structurer who was paid 5-10bps, but they remained unfunded until certain events, price or spread triggers, occurred.  Now holders are having to fund them, tantamount to a draw upon a liquidity facility that results in the super senior exposure (first in payment waterfall).  Is this basically correct?  What is meant by super senior exposure to a mezz structure, is that a CDO whose reference collateral is all mezz tranches in other words a CDO^2?  Thanks.

[curmudgeon]

1. As you'd expect dealers try to place super senior with monolines/reinsurers..this was easier done till around late 2005 ..when we all forgot what risk is ( and spreads refeflected that) and around 70% of most super seniors started to be retained.



2. Unfunded Superseniors are something akin to 'variable -funded' notes..ie a liquidity facility /funding comes in as and when required. : Unlike the SIV structures there is no immediate threat of funding ( as in NOW ...yet) . The latest EOD problems give SS holders a choice whether to liquidate/accelerate/continue..most are waiting and watching....guess what happens if liquidations start ...would other banks need to start to write down their superseniors to liquidation valuations?...that would be fun.



2. Mezz ABS CDO are constructed using underlying RMBS which is usually rated A/BBB. Yes they are resecuritization products.



3. Monolines/reinsurers preferred high grade stuff , so most of the supersenior on dealer books would be inferior mezz paper..and seeing the substantially worse write offs.

[curmudgeon]

413. I cannot count beyond 2.

[kr]

I don't really follow the below...



First, let's just call it 'senior'. 'Supersenior' used to represent something which was attached above a rating-agency AAA, then there was 'leveraged supersenior' which looked mostly like the tranche below that one, still with AAA attachment point. At this moment, there doesn't seem to be anything 'super' about these tranches anyhow. So let's just call them seniors.



Second, they are just credit risk, generally on a 'high but wide' tranche. So the usual discussions around how that risk is traded, and what the associated counterparty risk is, is key. They pay a minimal upside, for a huge downside. So if the subordination starts to fall apart, counterparty risk is going to grow. Few people have credit lines big enough for this, so generally they are either (a) funded entirely, or (b) subject to CSA, in which case they get margined (read 'funded') as the MTM drops. Alternatively, they are (c) put in CP conduits, which fund on a rolling basis in the commercial paper markets, which then fell apart, and the conduit itself has a liquidity line with its sponsor, so in a way, 'triggers' are putting these to bank balance sheets. But that is a function of the CP markets rather than the supersenior tranches. Finally, there is (d) the monoline business, who operate generally on a guarantee basis rather than through standard CDS, which means that the credit line issue reappeared, particularly as monoline spreads have exploded. This is causing most of the street to have shut down their monoline credit lines right now. But the counterparty risk still exists, so people go after intermediators - i.e. 3rd parties who face the monoline under the gtee and face the other party under CSA, and take/manage the monoline credit line dynamically. You can imagine that this is a bit of a messy business right now. Again, (d) is a monoline story rather than one about any particular kind of credit risk (except for the correlation since the monolines tend to be in the seniors).



'Variable Funded Notes' is a different term whereby a revolving-type credit line is funded as a note rather than a loan. You have VFNs when you don't want a loan for booking or other reasons. Often VFNs coincide with CP conduits, but they don't have to.



There are two separate issues with this senior risk right now. On the one hand, concerns in the USHEL market has people worrying about whether the underlying risk is AAA or not. This concern got people into a selling mode, which accelerated the decline in MTMs. That either caused line utilisation to shoot up, or caused the assets to be ineligible for SIVs / CP conduits etc., and MTM spiraled down further. Defensive triggers in the owning structures (i.e. mainly SIVs) led to credit downgrades because of the 'accelerating' nature of the problem - i.e. the structure should be able to repay itself not just through the AAA repayment of the asset but through liquidity at the MTM and essentially finding other holders who would take AAA repayment for a price. Banks had set themselves up to be either the backstop, through liquidity arrangements, or through trading, which looked like an opportunity but was more a falling-knife situation. That has dried up all of their liquidity as they are now bloated with assets. Hence MTM continues downward b/c there is no more loose money to soak up the market on offer - you can easily see it in credit spreads of banks like Citi.

[Cheng]

[i]I believe in a synthetic CDO they were often retained by the dealer/structurer who was paid 5-10bps[/i]



Why should they ? Synthetics trade as single tranches nowadays which means the dealer issues exactly one tranche, namely the one you buy and tries to delta-hedge it. There is no additional super senior tranche. This was different in the days of balance sheet CDOs where you had all the assets on your books and issued the whole cap structure.



[i]What is meant by super senior exposure to a mezz structure[/i]



Never heard of this one. Maybe leveraged super senior as mentioned by KR.

[baghead]

What is meant by super senior exposure to a mezz structure



dimsdale, could it be that you are referring to the mezz exposure of a super senior? synthetic super seniors are priced on a (base) correlation surface obtained from liquid tranches. These do only exist until a detachment point of 22% (the remaining losses are assumed to be in the super senior).

Slightly oversimplifying, one could say that the super senior equals the index (full capital structure) minus the junior tranches (0-22%).



Since these junior tranches are the observable market variables to price a super senior you can obtain "Deltas" of a super senior for changes in Equity, Mezz and Senior.



Edit: This btw shows how super seniors are hedged. If a dealer gets hit in 22-100 protection he buys all the junior tranches to complete the capital structure and trades the index notional by notional against it. the remaining risk is only a coupon mismatch in case losses start eating into the capital structure (similar to an index arb trade)

[Struct.Cred]

What is meant by super senior exposure to a mezz structure



ABS CDOs aren't my forte, but I do believe this refers to the supersenior piece of a mezz ABS CDO. I.e. a CDO using BBB/A ABS tranches as collateral.

[Skillionaire]

"What is meant by super senior exposure to a mezz structure"



As far as I know, not a damn thing.  That's pure jibberish. 



"ABS CDOs aren't my forte, but I do believe this refers to the supersenior piece of a mezz ABS CDO. I.e. a CDO using BBB/A ABS tranches as collateral."



SC, the case that you're referring to would be mezz collateral, not structure.  High grade and mezz CDOs have the same structure, just different underlying collateral.

[curmudgeon]

Thanks Kr , your last paragraph is really succint as usual.



Regarding the unfunded seniors in general :



1. My understanding here is that, in the day cash ABS assets were pretty scarce and people started building in more and more synthetic assets into these structures, creating a mismatch between assets and liabilities ( which used to be funded) : to manage this they either a) created reserve accounts yielding next to nothing for the extra funds coming in from the liability side b) had unfunded (senior) liabilities...



: I understand all cash asset structures would just have a wrap from a monoline with the dealer funding it themselves?...in which case dealers just have a LOT of monline rated paper about to be scuppered.



2. You said that the seniors are "...[i](a) funded entirely, or (b) subject to CSA" .[/i]  the CSA you refer to here would be on the wrap with the monoline right?. Are monolines actually posting collateral to the dealers given where seniors are being valued?....This would be bit problematic for dealers ...on the one hand the would want to collateralize the exposure to the monolines as much as possible ...but not show too low a value on their own holdings!



To me atleast where you have synthetic assets the VFN seems to be the way to go...sort of as a pay as you go...I dont have any statistics on how popular this structure is (was) but hard for me to look past it.

[kr]

re 1) I don't think that's it... there was a point where originating banks wanted to get short as a means of hedging their pipeline, but this wasn't really the main thing. The ALM mismatch came from arbitrage pressure - i.e. people thought they could create even cheaper senior funding through conduit finance, because at the time, demand for the assets was so high that equity IRR was not even in the double digits. The point is that this was a creature of bubble life - i.e. every asset too expensive, and finding creative ways to get even cheaper leverage.



Re: reserve funds, this is not quite right... in very highly levered deals like high-grade ABS CDOs, the timing of cashflows on the assets is pretty critical and you can't have coupon money sitting around at L-20. This is also true in SIVs where cash reinvestment was carefully managed in order to keep the arbitrage optimal.



The whole monoline thing had more or less fallen away by the time ABS CDO was in its 'prime' (harhar)... overall a wrap on the senior paper represents a drag on structure inefficiency, so that was left out and investors relied solely on the rating agency result. Ok, in retrospect, with the wrap it might not have been worth a whole lot more... my point is a bit indirect - I think ABS CDO exposure at the monoline level is not as big as people seem to think it is.



On 2), no, there is no CSA with the monoline - that is part of the game. Intermediators would have provided that service... at a price which in today's market would look totally inadequate. In reality, the kind of players who will trade with you under CSA are not the ones who want to buy AAA paper at L+1 bp, except maybe banks under TRS facilities. Standing in between a AAA entity who doesn't post collateral, and a market counterparty bank who requires collateral, is a tricky game that I will not try to defend on its merits here.



At the end of the day, having CP investors put up cash was a great thing but the liquidity crunch front-ran the structure... i.e. either the CP investors got taken out by the sponsor bank, in which case the structure was so robust that the investors didn't take any risk, or, they were left for dead and are going to get 70-90% recovery on default. The problem is that 'pay as you go' is a sensitive subject... retail will never play that - they have to pay upfront, and other players will just say ok, if you want me to collateralise then I want a par put to you. I think it is the result of the front office not wanting to really address liquidity issues which seemed very theoretical at the time... nobody envisioned the hell we are currently in.