How Core became Cast

Few banks better illustrate how the market has shifted from cashflow to synthetic CLOs than Deutsche Bank. The bank has been one of the biggest issuers of conventional CLOs, securitizing several billion euros-worth of corporate loans through its Core series of transactions in 1998 and 1999.

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But at the end of 1999 Deutsche changed tack. The latest deal in the series was secured on a similar portfolio of corporate loans to the earlier Core deals, but this time Deutsche used a synthetic structure. The deal was branded Cast. "The primary reason we utilized the synthetic structure for Cast was to achieve transfer of the credit risk without the requirement to raise funding against the loans," explains Tamara Adler, head of securitization at Deutsche Bank in London.
The truth about securitization in Europe is that most banks - and Deutsche is surely no exception - can raise funds more cheaply if they borrow directly rather than by issuing asset-backed bonds. Freeing up capital by transferring risk synthetically can make a lot more sense.
Cast is also notable for a structural innovation: it reintroduces the credit-linked note into CLOs. Back in the early days of bank balance sheet CLOs, SBC used credit-linked notes in its Glacier structure. But the idea never took off. The problem with using CLNs was that the notes could be rated no higher than the issuer itself. That made it difficult for deals such as Glacier to be cost-effective.
Cast builds on two earlier structures. Like JP Morgan's Bistro, the classic synthetic CLO, it uses leverage to make the structure cost-effective. In a leveraged CLO most of the credit exposure in the pool is transferred not by issuing bonds but through a default swap with a triple-A counterparty, often a monoline bond insurer or some other kind of insurance company. This insures against the remote possibility of losses in the portfolio rising to catastrophic levels. It means the bank needs to fund only a small part of the portfolio by issuing bonds.

The proceeds of the bonds are not passed on to the parent bank but are invested in some kind of triple-A collateral. This credit enhancement is what allows the most senior bonds to be rated higher than the originating bank. In most leveraged synthetic CLOs, the collateral consists of government bonds. But Cast, like HypoVereinsbank's Geldilux before it, uses the issuer's own Pfandbriefe (or rather Pfandbriefe issued by a sister mortgage bank) as collateral, thus reducing the cost of the deal for the issuer.
Where Cast differs from Geldilux is that the bonds are not issued by a special purpose vehicle but directly by Deutsche Bank itself. This is where the credit-linked notes come in. Geldilux and most other synthetic CLOs transfer the credit risk in the portfolio to bond investors by a default swap between the SPV and the originator of the loans. In Cast, the notes are direct obligations of Deutsche Bank, but their performance is linked to the underlying pool. If losses in the pool reach a certain level, the notes will stop paying.
"Using credit-linked notes in this way is a natural progression from the development of synthetic structures," Adler believes. "It means you don't have to undertake the task of setting up a special purpose vehicle. It's simply an easier structure to utilize."

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How Core became Cast

Few banks better illustrate how the market has shifted from cashflow to synthetic CLOs than Deutsche Bank. The bank has been one of the biggest issuers of conventional CLOs, securitizing several billion euros-worth of corporate loans through its Core series of transactions in 1998 and 1999.

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Add Your Comment

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