casemark/analyzing-synthetic-securitization-structures

Analyzing Synthetic Securitization Structures

When To Use

• Evaluating a synthetic CDO (collateralized debt obligation) where credit risk is transferred via credit default swaps rather than true sale of assets
• Analyzing credit risk transfer (CRT) programs such as Fannie Mae Connecticut Avenue Securities (CAS) or Freddie Mac Structured Agency Credit Risk (STACR)
• Reviewing funded vs. unfunded tranche mechanics in a bespoke or managed synthetic structure
• Assessing counterparty exposure, collateral posting requirements, and credit event definitions in CDS-based securitizations
• Comparing synthetic structures against cash equivalents for capital relief, regulatory treatment, or risk retention purposes

Inputs To Gather

• Structure term sheet or offering circular — tranche definitions, attachment/detachment points, notional amounts, coupon mechanics
• Reference portfolio details — obligor count, sector/geographic concentration, weighted-average rating, weighted-average life
• CDS confirmation or ISDA schedule — credit event definitions (bankruptcy, failure to pay, restructuring), settlement method (physical vs. cash vs. auction), materiality thresholds
• Collateral account terms — eligible investments, haircut schedules, rehypothecation rights, substitution triggers
• Waterfall mechanics — interest and principal priority of payments, loss allocation sequence, write-down/write-up mechanics
• Counterparty information — protection buyer/seller ratings, replacement triggers, collateral posting thresholds under CSA [VERIFY against specific CSA terms]

Workflow

1. Map the structure diagram

   • Identify the protection buyer (originator/sponsor) and protection seller (SPV or direct counterparty)
   • Classify each tranche: super-senior (typically unfunded CDS wrap), mezzanine (funded or unfunded), first-loss/equity
   • Note whether the SPV is bankruptcy-remote and whether funded tranches issue credit-linked notes (CLNs)

2. Analyze credit event mechanics

   • Confirm which ISDA credit events apply — standard corporate CDS vs. sovereign vs. LCDS for loans [VERIFY: 2003 vs. 2014 ISDA definitions]
   • Assess whether restructuring is included (Modified Restructuring, Mod-Mod-R, or Old-R) and how it affects loss allocation
   • Determine settlement method: cash settlement with dealer poll/auction, physical settlement, or fixed recovery

3. Evaluate funded vs. unfunded tranches

   • For funded tranches: review CLN terms, collateral account eligible investments, and mark-to-market triggers
   • For unfunded tranches: assess counterparty credit quality, collateral posting obligations, and replacement language
   • Calculate the effective cost of protection across funded (coupon = SOFR + spread) vs. unfunded (CDS premium only) tranches

4. Model loss allocation and waterfall

   • Map attachment and detachment points for each tranche to determine subordination levels
   • Stress-test reference portfolio using base, adverse, and severely adverse scenarios (e.g., 2x–5x historical default rates)
   • Assess expected loss, probability of tranche impairment, and implied ratings at each stress level
   • Identify any write-down/write-up mechanics — are losses allocated on a mark-to-market or realized-loss basis?

5. Assess counterparty and basis risk

   • Evaluate protection buyer default risk — what happens to the SPV and noteholders if the originator fails to pay premiums?
   • Review collateral account risk: can principal be impaired by eligible investment losses?
   • Identify basis risk between CDS reference obligations and actual portfolio (naming mismatch, maturity mismatch, currency mismatch)

6. Review regulatory and capital treatment

   • Determine whether the structure achieves significant risk transfer (SRT) under applicable capital framework [VERIFY: Basel III/IV, CRR2 Article 244–245 for EU, US agency rules for CRT]
   • Assess risk retention compliance — does the originator retain a material net economic interest? [VERIFY: EU Securitisation Regulation Article 6, US Dodd-Frank Section 941]
   • Evaluate accounting treatment: does the synthetic transfer achieve off-balance-sheet treatment or only capital relief?

Output

Produce a structured analysis report containing:

• Structure Summary — diagram or table showing parties, tranche stack (super-senior through equity), notional amounts, attachment/detachment points, funded/unfunded status
• CDS Mechanics Summary — credit events, settlement method, reference obligation characteristics, maturity profile
• Tranche-Level Analysis — for each tranche: subordination, expected loss, implied rating, coupon/premium, key risks
• Stress Testing Results — portfolio loss scenarios mapped to tranche impairment thresholds, with probability-weighted outcomes
• Counterparty Risk Assessment — exposure quantification for unfunded tranches, collateral adequacy for funded tranches
• Regulatory/Capital Treatment — SRT eligibility conclusion, risk retention status, accounting impact
• Key Risks and Mitigants — basis risk, counterparty risk, collateral risk, documentation gaps, with recommended mitigants

Quality Checks

• Confirm all attachment/detachment points sum correctly across the capital structure and match the total reference portfolio notional
• Verify that credit event definitions in the CDS confirmation are consistent with the offering circular/term sheet
• Cross-check loss allocation waterfall against both the indenture and the CDS documentation for any conflicts
• Ensure stress scenarios are calibrated to the reference portfolio's asset class (corporate, RMBS, CMBS, leveraged loans) — do not apply generic assumptions
• Validate that regulatory capital conclusions cite the correct jurisdictional framework [VERIFY]
• Flag any mismatch between the CDS reference portfolio and the originator's actual retained portfolio
• Confirm collateral account eligible investment criteria are sufficiently conservative relative to tranche ratings