Collateral Bond Obligation

ORE describes the underlying portfolio as follows:

The underlying assets consist of a portfolio of corporate bonds or loans with either amortising or bullet structures. The portfolio can contain fixed or floating rate obligations. Maturities cover a range and do need not coincide. We assume that hazard rate data is available and provided externally.

Source: ORE User Guide, Products catalogue, cbodata.tex.

ORE describes the cashflow structure as follows:

The deal is assumed to be structured as a cashflow securitisation. Interest and Notional repayments are directed in an order of priority first to the note holder.

Source: ORE User Guide, Products catalogue, cbodata.tex.

ORE describes the role of the equity piece as follows:

Class N notes or equity receive the excess pool coupon available after other items in the interest waterfall are discharged.

Source: ORE User Guide, Products catalogue, cbodata.tex.

A CBO repackages a pool of corporate bonds into notes with different risk. The pool pays its coupons and its capital into a waterfall. The waterfall pays the notes in a fixed order of priority. Senior notes are paid first. The equity note gets what is left after every other item is discharged. Early losses fall on the equity and the junior notes first.

ORE defines the two setup forms as follows:

A Cashflow CDO or Collateral Bond Obligation CBO (trade type CBO) can be set up in a short version referencing the underlying CBO structure in a static CBO reference datum or a long version, where the CBO structure is specified explicitly.

Source: ORE User Guide, Products catalogue, cbodata.tex.

The main building block is the CBOData node. It requires two components: CBOInvestment and CBOStructure. In the short version the CBOInvestment component alone specifies the deal; the CBOStructure component can be omitted.

The CBOInvestment component carries three elements. TrancheName names the tranche whose results are shown in the report files; the name must match one of the names in CBOTranches. Notional is the amount invested in that tranche; it scales the NPV of the generic tranche. StructureId is the key used when the structure is read from reference data.

The CBOStructure component carries the general structure. Its elements follow:

• DayCounter and PaymentConvention apply to the tranches.
• Currency defines the currency of the trade.
• ReinvestmentEndDate ends the reinvestment period.
• SeniorFee is a rate paid before all other obligations, at the top of the waterfall.
• FeeDayCounter is the day count convention for the fees.
• SubordinatedFee is a rate paid after all other obligations.
• EquityKicker splits the residual between the senior fee receiver and the equity piece.
• BondBasketData holds the specifications of the underlying bond basket.
• CBOTranches holds the instrument data for the tranches of the deal.
• ScheduleData holds the schedule of the trade.

ORE defines the equity kicker as follows:

EquityKicker: Fraction x of the residual payment, that will be split among the senior fee receiver (x) and the equity piece (1-x).

Source: ORE User Guide, Products catalogue, cbodata.tex.

The fees themselves follow the same pattern. ORE describes them as follows:

The fee, expressed as rate, paid before all other obligations, top of the waterfall.

Source: ORE User Guide, Products catalogue, cbodata.tex.

The fee, expressed as rate, paid after all other obligations.

Source: ORE User Guide, Products catalogue, cbodata.tex.

The deal has n tranches, one for each note. Each tranche is defined by an attachment point and a detachment point. The tranches absorb the losses of the pool in order of seniority, from the equity note up to the senior note.

The waterfall is the pricing core of the deal. The interest waterfall pays taxes, trustee and administration fees up to their caps, hedge payments, the liquidity facility and the servicing fees. It then pays the note coupons in seniority order. Senior notes are redeemed early when the over-collateralisation or interest coverage tests fail. Interest flows down the deflection tests to the subordinated items, then to the equity note up to an IRR hurdle. A management incentive fee is paid before the final excess reaches the equity note.

The principal waterfall works on capital. It first pays the unpaid interest items, then redeems the notes in seniority order. During the reinvestment period it buys additional securities instead of redeeming notes.

ORE summarises the two waterfalls as follows:

In summary, Interest after tax and expenses goes first to the Senior note holders and then on down the order of priority and finally to the equity noteholder after ensuring that any tests are satisfied. Notional repayments after expenses go to redemption of the senior notes and finally to the equity note holder.

Source: ORE User Guide, Products catalogue, cbodata.tex.

The pool of the deal behaves differently inside and outside the reinvestment period. ORE notes a model limit as follows:

Currently the model cannot handle underlying bonds with full amortisation within the reinvestment period.

Source: ORE User Guide, Products catalogue, cbodata.tex.

• The credit of the pool issuers. The hazard rates come from outside the trade; defaults and recoveries feed the waterfalls.
• The level of interest rates, for floating rate coupons and for discounting.
• The value of the underlying bonds, through their coupons and redemptions.
• The structure of the deal: the fees, the equity kicker and the over-collateralisation and interest coverage tests.
• The seniority of the tranche the trade holds.

The value of a booked tranche is its share of the waterfall. The senior notes feel the pool only when the losses reach their attachment point. The equity note feels every loss first.

The pool pays its coupons and amortisations into the waterfall on the payment dates. Until the reinvestment end date, principal proceeds buy more assets instead of redeeming notes. After that date the proceeds redeem the notes in seniority order. Failed coverage tests can force senior redemptions at any time. As the pool ages and defaults, the remaining value flows down the order of priority to the equity note last.

A CBO turns a credit portfolio into tradeable notes of different seniority. A customer buys senior notes for low-risk yield, or equity notes for leveraged credit exposure. An originator uses the structure to fund a portfolio off balance sheet. In ORE Studio a customer books CBOs to value them and run sensitivities on the ORE engine.

ORE's catalogue shows a long-version CBO on a EUR structure. The trade invests 4 million in a junior note of the Constellation structure, with a senior fee of 1 percent, a subordinated fee of 2 percent and an equity kicker of 0.25:

<CBOData>
  <CBOInvestment>
    <TrancheName>JuniorNote</TrancheName>
    <Notional>4000000.00</Notional>
    <StructureId>Constellation</StructureId>
  </CBOInvestment>
  <CBOStructure>
    <DayCounter>ACT/ACT</DayCounter>
    <PaymentConvention>F</PaymentConvention>
    <Currency>EUR</Currency>
    <ReinvestmentEndDate>2019-12-31</ReinvestmentEndDate>
    <SeniorFee>0.01</SeniorFee>
    <FeeDayCounter>A365</FeeDayCounter>
    <SubordinatedFee>0.02</SubordinatedFee>
    <EquityKicker>0.25</EquityKicker>
    <BondBasketData>
      ...
    </BondBasketData>
    <CBOTranches>
      ...
    </CBOTranches>
    <ScheduleData>
      ...
    </ScheduleData>
  </CBOStructure>
</CBOData>

Source: ORE User Guide, Products catalogue, cbodata.tex, listing CBO Data. The source elides the contents of the three sub-nodes with dots; they are reproduced verbatim.