How does GE Greatlink Choice Work
Following the blowups of Lehman Minibond, DBS High Notes, Merrill Lynch Jubliee Notes and Morgan Stanley Pinnacle Notes, Greatlink Choice Funds, another similar product introduced by Great Eastern (GE), has also ran into potential problems. Below is my attempt to explain how the funds work and the difference between Greatlink Choice and the other products.
GE GreatlinkChoice is basically a Synthetic CDO. Refer to the previous post Termination of Swaps for Lehman Minibond to understand how a Synthetic CDO work. This post can be taken a continuation of the Synthetic CDO explanation. The figure below illustrates how the Synthetic CDO work. Click on the figure for a clearer view.
The investors are actually buying into different tranches of the CDO with different seniority as represented by the red square above. The senior tranches have the highest credit rating in the sense that the first defaults will be taken by the more junior or subordinated tranches. The figure below shows the breakdown of the tranches.
The Key Terms to Know:
- Attachment Point/Subordination/Loss Protetion - The level whereby the tranche will start to lose its principal
- Detachment Point – The level whereby the tranche will lose ALL of the principal
- Tranche Size – The difference between Detachment Point and Attachment Point
- Recovery Rate – The rate in percentage at which creditors are able to recover from the defaulted bond
Now for a bit of Math. Assumption:
- The CDO portfolio: 100 Reference Entities with equal weighting (ie, 1% each)
- Recovery Rate: 50%
- Attachment point/Subordination/Loss Protection: 10%
- Detachment Point: 12%
- Tranche Size = 12%-10% = 2%
Loss per Credit Event = 1% X (1 – Recovery Rate) = 1% (1- 50%) = 0.5%
No. of Sustainable defaults = Subordination/Loss per Credit Event
= 10%/0.5% = 20
Meaning to say, this particular tranche can take up to 20 Credit Events before the Attachment Point is triggered.
Number of additional Credit Event before complete loss = Tranche Size/Loss per Credit Event = 2%/0.5% = 4
This means that from the tranche will lose everything on the 24th Credit event
Loss per additional Credit Event = 100%/4 = 25%
The tranche will lose 25% from each subsequent Credit Event from the 21st to the 24th
The above calculation is illustrative as the portfolio weightage, Recovery Rate, Tranche Size etc may vary from CDO to CDO. It is unlikely to have such nice looking whole numbers.
How is GE Greatlink Choice funds different from the Lehman-linked Structured Notes?
1. GE GreatLink Choice is a fund under a Single Premium Investment-Linked-Product (ILP) sold by an insurance company where the Lehman-linked notes are structured notes sold by banks and other financial institutions.
2. Lehman-linked structured notes have a First-to-Default clause which will trigger unwinding if just 1 of the Reference Entities have a Credit Event. As explained above, there must be a certain number of Credit Events to trigger a partial or total loss for Greatlink Choice.
3. The Lehman-linked notes have Synthetic CDO embedded in a CDO whereas the Greatlink Choice funds are just Synthetic CDO.
Will the Greatlink Choice have a partial of complete loss?
It may or it may not. There are already some Credit Events (1 for Sept and Oct 2010 fund, 4 for Oct 2012 and Aug 2013 and 5 for Dec 2013) and more Credit Events may cause partial or total loss depending on the individual fund’s structure. Note that the defaulting of the Swap Counterparty may also cause a loss.
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Tags: Structured Prd
