Warehousing is a process of forming assets for a forthcoming collateralized debt obligation (also called CDO), these assets comprise loans and bonds and they’ll perform as collateral in a CDO transaction. In finance warehousing has quite a similar meaning it has in everyday life. Usually warehousing is carried out by an asset manager and lasts two or three months until the closing of all transactions and after they’ll be securitized and sold.
Connection between a CDO and Warehousing
The name collateralized debt obligation comes with bonds, mortgages, loans as they are debt obligations and play the collateral role in a transaction. A collateralized debt obligation is a well-organized financial product, it puts together cash assets, then rearranges new packages of assets into separate tranches that may be sold to everyone interested in investment. There are different types of a CDO depending on their risk profile. The first is senior tranches, the second is junior tranches. While senior tranches are less dangerous as in case of a default they have priority, junior tranches have a rather lower credit ratings from the agency. Also, senior tranches don’t bring less profit than junior tranches.
When an investment bank wants to launch a CDO in order to prepare it needs to conduct a warehousing of assets. Warehousing lasts before the target or desirable amount is achieved, all the assets are kept in a special account called warehouse account. As soon as the needed amount is met, the assets are sent to the corporation set up for the CDO. Unfortunately, a CDO may put the bank under capital risk as all the assets are only in its books. The bank can try to limit risk in financial assets by hedging.
Risks of Warehousing
Warehousing seems a simple process, however, it may carry certain risks. It may seem that a market has a great demand for a CDO, and companies will start to carry out warehousing in order to launch more and more CDOs. However, if it appears that demand wasn’t as great as it seemed to be, people who already hold CDOs will lose big amounts of money. Therefore warehousing may be even dangerous.