The five-year, e237 million Thunderbird Series Three CDO is backed by 36 ABS tranches and three synthetic mezzanine CDO tranches. This reference portfolio is worth over e7.7 billion.
In the deal, Thunderbird Investments sells credit protection on the reference portfolio. To collateralize its obligations under the sale, it issues secured floating-rate and variable-rate notes in Australian dollars, euros, yen, US dollars and Swiss francs. The proceeds are invested in AAA rated ABS and AA- rated government bonds under a repurchase agreement with BNP Paribas. Forex swaps keep the collateral denominated in euro.
Thunderbird Three breaks new ground in synthetic CDOs of ABS. It is the first CDO of ABS rated by Standard & Poor’s where, under the credit default swap, the issuer provides for a fixed level of recoveries if the reference obligations are affected by credit events.
“Because recovery is fixed, the impact of a certain set of credit events is known in advance,” says Antoine Chausson, head of credit derivatives structuring at BNP Paribas. “That caters to investors who want a simpler structure.”
And with a fixed recovery structure, there’s no need for time-consuming valuation after a credit event. That means the final legal maturity date of Thunderbird Three is just three months after the scheduled maturity date.
Secondly, the second largest of Thunderbird Three’s 13 tranches is a five-year euro FRN
linked to the five-year Constant Maturity Credit Index (CMCI). The notes pay a semi-annual coupon of Euribor plus CMCI. This helps investors that want to buy CDOs of ABS but expect credit spreads to increase in the medium term. The CMCI is worked out using linear interpolation between the September 2008 and September 2013 Trac-X series of indices.
“With this tranche, investors can take advantage of spreads going back up, because the coupon is Euribor plus CMCI,” says Chausson. “When the curve is positive, negative carry means they will make Euribor plus 100% of that spread.”
Thunderbird Three is the first publicly launched and rated deal of this type to use a CMCI. “This is made possible by the liquidity of the Trac-X series,” says Chausson.
Thirdly, on each maturity date, holders of Thunderbird’s variable notes have the option to switch from a Euribor benchmark to a fixed-rate coupon based on swap rates.
“Fixed-rate investors who buy the variable notes are happy to buy risk today in floating-rate form,” says Chausson. An investor wanting to switch to the fixed rate in March 2004, for example, would base the fixed rate on the then prevailing swap rate to March 2009.
Investors are pushing the CDO squared market in new directions. “In all CDOs of CDOs and ABS, the basic building blocks of repos and reference obligations are the same,” says Chausson. “Investors are comfortable with that now. Most of our transactions are really reverse enquiry deals. On Thunderbird Three, we managed to get strong interest in the underlying portfolio and the building blocks. Then we found that investors were interested in the more novel structures.”
Thunderbird Investments is an Irish special purpose vehicle. The bank pioneered CDO of ABS technology with its Arum single-issue vehicle in Luxembourg, through which it issued the first CDO of ABS rated by Moody’s and Fitch, and through Iliad, another Irish vehicle that has issued 10 CDOs of ABS.
Because CDO squared deals often start with a small group of investors looking at a potential portfolio, then develop as the originator adds different features and a larger investor group takes an interest, they often need to be increased. On Thunderbird Three, the FRN tranche was raised from e50 million to e100 million. “The structure allows for a rateable increase at any time,” says Chausson. “When we increase a tranche, we proportionally increase the mezzanine swap and the repo.”
Standard & Poor’s rates the Thunderbird deals using its drill-down methodology. This involves examining each asset in the reference portfolio to assess the impact of a default by a single name that appears in more than one of the underlying CDOs. It also compensates for the fact that, within the pool of reference assets, ABS deals generally have higher recovery rates than CDOs. A Monte Carlo model is run, but potential defaults are automatically assigned their own recovery rate. This stops a CDO of ABS getting a disproportionately high rating because of its ABS component, which could happen if a weighted average recovery rate were used.
