Legal considerations for CDO Transactions.

• Author: Manzi, Rosaleen
• Position: Collateralized debt obligations

This article broadly describes the methodology used in reviewing the legal aspects of CDO securitization structures and the application of that methodology to the most commonly used U.S. structures. Nevertheless, it provides a useful guide to structuring CDO transactions in non-U.S. jurisdictions.

1. INTRODUCTION

   CDO transactions are rated primarily on the basis of the credit quality of the assets supporting the rated securities. The analysis of legal documents and, where appropriate, receipt of opinions of counsel that address insolvency and other issues, can resolve most legal concerns. Understanding the implications of assumptions made and criteria used enables an issuer to anticipate and resolve most legal concerns early in the rating process. (For a more detailed analysis of some of the issues discussed in this section, see Standard & Poor's April 2002 publication "Legal Issues in Rating Structured Finance Transactions.')

   It is beyond the scope of this article to describe in depth the CDO criteria used in each of the jurisdictions that has one or more rated transactions. Rather, this article broadly describes the methodology used in reviewing the legal aspects of CDO securitization structures and the application of that methodology to the most commonly used U.S. structures. Nevertheless, it provides a useful guide to structuring CDO transactions in non-U.S. jurisdictions. Sponsors looking to structure non-U.S. transactions should discuss their transactions with Standard & Poor's early in the rating process, in order to resolve jurisdiction-specific legal and structural issues.

2. CDO TRANSACTIONS

   In CDO transactions, the issuing SPE purchases a pool Of loans and bonds. In general, Standard & Poor's criteria for CDO transactions include the following considerations.

   If the issuing SPE purchases the bonds in open market transfers, Standard & Poor's generally will not require a true sale opinion. If the bonds had been held in the transferor's portfolio for more than approximately three months, or they had been reported by the transferor other than as assets held for resale, Standard & Poor's generally will require a true sale opinion from the transferor to the issuing SPE.

   As in structured transactions involving other asset types, Standard & Poor's generally will require inclusion of the applicable Uniform Commercial Code (UCC) Representations and Warranties in the relevant security agreement or, in specific circumstances, a security interest opinion in connection with the grant of a first priority perfected security interest from the issuing SPE to the indenture trustee/collateral agent for the benefit of the CDO holders and an entity-level tax opinion.

3. CLO TRANSACTIONS

   In balance sheet CDO transactions, the transferor, generally a bank, wishes to securitize direct loans made to its customers (either term or revolving loans), or syndicated loans on which the bank has a funding obligation. To date, Balance Sheet CDO transactions have been structured by both FDIC-insured banks and by the U.S. branches of foreign banks.

   If the loan being securitized is freely assignable, then the transaction is structured the same (and Standard & Poor's criteria are the same) as other asset-backed transactions. In most transactions, however, the loan agreement contains restrictions or limitations on the outright sale of the loan to a third party. Because of these restrictions and limitations, most of the balance sheet CDO transactions rated by Standard & Poor's to date have been structured as participations. However, the July 2001 revisions to...