Single Tranche CDO

Single Tranche CDO is a natural extension of full capital structure Synthetic CDO deals. These are bespoke transactions where the bank and the investor work closely to achieve a specific target. In a bespoke transaction, the investor has 100% say on the rating of the tranche, maturity of the transaction, coupon type (fixed or floating), subordination level, type of collateral used etc. Typically the objective is to create a debt instrument where the return is significantly higher than comparably rated bonds. This is also viewed as rating arbitrage, hence these CDOs are also called Arbitrage CDO's. In a nutshell, a single tranche CDO is a CDO where the issuing bank effectively holds the rest of the capital structure and does not place it.

Full Capital Structure CDO's

In a full capital structure transaction, the total nominal of the notes issued equals to the total nominal of the underlying portfolio. Therefore, the full capital structure transaction requires all of the tranches being placed with investors.

Full Capital Structure Deal Example

Consider a USD 1,000,000,000 consisting of 100 entities. Furthermore, consider an SPV which has no assets or liabilities to start with. In order to purchase this USD 1,000,000,000 portfolio it has to borrow USD 1,000,000,000. Instead of borrowing USD 1,000,000,000 in one go, it borrows in tranches and which have different risks associated with them. As an example consider the following transaction:

How does it work?

In the above example, the investor is making a USD 10,000,000 investment. He will receive USD 6month Libor + 1.00% as long as the cumulative losses in the Reference Portfolio remain below 5%. If for example at the end of the transaction the losses in the portfolio remain below 5% the investor will receive USD 10,000,000 back. If however, the losses in the portfolio is USD 52,000,000 which corresponds to 5.2% the investor will lose 20% of his capital, i.e. he will receive only USD 8,000,000 back. The coupon he receives will be on the reduced notional from the moment the portfolio suffers a loss that affects the investor.