Collateralized Debt Obligations Structures and Analysis

by Lucas, Douglas J.; Goodman, Laurie S.; Fabozzi, Frank J.

• ISBN13: 9780471718871
• ISBN10: 0471718874
• Edition: 2nd
• Format: Hardcover
• Copyright: 2006-05-05
• Publisher: Wiley

Summary

Since first edition's publication, the CDO market has seen tremendous growth. As of 2005, $1.1 trillion of CDOs were outstanding -- making them the fastest-growing investment vehicle of the last decade. To help you keep up with this expanding market and its various instruments, Douglas Lucas, Laurie Goodman, and Frank Fabozzi have collaborated to bring you this fully revised and up-to-date new edition of Collateralized Debt Obligations. Written in a clear and accessible style, this valuable resource provides critical information regarding the evolving nature of the CDO market. You'll find in-depth insights gleaned from years of investment and credit experience as well as the examination of a wide range of issues, including cash CDOs, loans and CLOs, structured finance CDOs and collateral review, emerging market and market value CDOs, and synthetic CDOs. Use this book as your guide and take advantage of this dynamic market and its products.

Author Biography

Douglas J. Lucas is Executive Director and Head of CDO Research at UBS. He is also Chairman of The Bond Market Association's CDO Research Committee and ranked top three in CDO research in the Institutional Investor's fixed income analyst survey. Lucas has been involved in the CDO market for nearly two decades, having developed Moody's rating methodology for CDOs in 1989.</p> <p>LAURIE S. GOODMAN, PhD, is Managing Director and co-Head of Global Fixed Income Research at UBS. She manages U.S. Securitized Products and Treasury/Agency/Derivatives Research. Goodman has worked on Wall Street for over twenty years and is well regarded by the investor community,?having won more #1 slots on the Institutional Investor All-American Fixed Income Team than any other analyst. <p>FRANK J. FABOZZI, PhD, CFA, CPA, is an Adjunct Professor of Finance and Becton Fellow at Yale University's School of Management and a Fellow of the International Center for Finance. Fabozzi is the Editor of the Journal of Portfolio Management.

Table of Contents

Preface	xiii
About the Authors	xxi
PART ONE Introduction to Cash CDOs	1	(40)
Cash CDO Basics	3	(14)
Why Study CDOs?	3	(1)
Understanding CDOs	4	(6)
Credit Structures	10	(3)
A CDO Structural Matrix	13	(1)
CDOs Being Offered Today	14	(1)
Parties to a CDO	14	(3)
Cash Flow CDOs	17	(24)
Distribution of Cash Flows	17	(3)
Restrictions on Management: Safety Nets	20	(3)
Credit Ratings	23	(15)
Call Provisions in CDO Transactions	38	(3)
PART TWO Loans and CLOs	41	(60)
High-Yield Loans: Structure and Performance	43	(32)
The Loan Market	44	(2)
The Syndication Process	46	(2)
Loan Structure and Leaders	48	(1)
Loan Interest Rates and Upfront Fees	49	(2)
Loan Credit Quality	51	(1)
Lender's Liability	52	(1)
Overview of Loan Terms	53	(5)
Loan Terms versus Bond Terms	58	(1)
A Tale of Two Loans	58	(2)
The Secondary Market	60	(1)
Loan Recovery Rates	61	(2)
Loan Default Rates	63	(4)
High-Yield Loan CLO versus High-Yield Bond CBO Performance	67	(7)
Conclusion	74	(1)
European Bank Loans and Middle Market Loans	75	(26)
European Bank Loans	75	(16)
Middle Market Loans	91	(8)
Conclusion	99	(2)
PART THREE Structured Finance CDOs and Collateral Review	101	(86)
Review of Structured Finance Collateral: Mortgage-Related Products	103	(32)
Residential Mortgage-Backed Securities	103	(22)
Commercial Mortgage-Backed Securities	125	(4)
Real Estate Investment Trust Debt	129	(6)
Review of Structured Finance Collateral: Nonmortgage ABS	135	(18)
Credit Card Receivable-Backed Securities	135	(2)
Auto Loan-Backed Securities	137	(2)
Student Loan-Backed Securities	139	(2)
SBA Loan-Backed Securities	141	(1)
Aircraft Lease-Backed Securities	142	(3)
Franchise Loan-Backed Securities	145	(3)
Rate Reduction Bonds	148	(5)
Structured Finance Default and Recovery Rates	153	(18)
Structured Finance versus Corporate Default Rates	154	(2)
S&P Rating Transition Studies and the Matrix Multiplying Approach	156	(2)
Results of Multiplying S&P Rating Transition Matrices	158	(1)
S&P on Structured Finance Loss Given Default	159	(1)
S&P Constant Annual Default and Recoveries	159	(1)
Moody's Material Impairment Study	160	(2)
Comparing and Reconciling Structured Finance Default Rates	162	(2)
Moody's on Structured Finance Historical Loss Rates	164	(2)
Moody's Constant Annual Default and Recoveries	166	(1)
Blending S&P and Moody's Studies	167	(1)
Applying CDRs and Recoveries to SF CDOs	167	(3)
Conclusion	170	(1)
Structured Finance Cash Flow CDOs	171	(16)
SF CDOs versus High-Yield CDOs	172	(2)
Rating Agencies on Structured Finance CDOs	174	(8)
Structured Finance Assets' Negative Convexity	182	(1)
Extension Risk	183	(2)
Conclusion	185	(2)
PART FOUR Other Types of Cash CDOs	187	(30)
Emerging Market CDOs	189	(12)
EM Sovereign Bond Defaults	190	(2)
Why the Better Track Record?	192	(1)
CDO Rating Differences: EM versus High Yield	193	(5)
Conclusion	198	(3)
Market Value CDOs	201	(16)
Cash Flow versus Market Value Deals	201	(1)
The Rating Process	202	(10)
How Advance Rates Are Derived	212	(3)
Conclusion	215	(2)
PART FIVE Synthetic CDOs	217	(82)
Introduction to Credit Default Swaps and Synthetic CDOs	219	(22)
Credit Default Swaps	219	(10)
Synthetic CDOs	229	(10)
Conclusion	239	(2)
Synthetic Balance Sheet CDOs	241	(14)
Cash CLOs for Balance Sheet Management	241	(8)
Partially Funded Synthetic CDOs	249	(4)
Conclusion	253	(2)
Synthetic Arbitrage CDOs	255	(10)
Full Capital Structure Synthetic Arbitrage CDOs	256	(4)
Single-Tranche CDOs	260	(1)
Standard Tranches of CDS Indices	261	(1)
Conclusion	262	(3)
A Framework for Evaluating Trades in the Credit Derivatives Market	265	(16)
Assessing Single-Name and CDO Tranched Exposures	266	(8)
Assessing CDO Equity versus a Basket Swap	274	(6)
Conclusion	280	(1)
Structured Finance Credit Default Swaps and Synthetic CDOs	281	(18)
Differences between Corporate and Structured Finance Credit	282	(2)
Difficulties in SF CDS	284	(10)
SF CDS Effect on SF CDO Management	294	(1)
Two New Types of SF CDOs	295	(1)
Effects of SF CDS on CDO Credit Quality and Spreads	296	(1)
Conclusion	297	(2)
PART SIX Default Correlation	299	(46)
Default Correlation: The Basics	301	(22)
Default Correlation Defined	301	(4)
Default Probability and Default Correlation	305	(16)
Conclusion	321	(2)
Empirical Default Correlations: Problems and Solutions	323	(22)
Empirical Results	323	(4)
Problems with Historical Default Correlations	327	(3)
Proposed Solutions	330	(14)
Conclusion	344	(1)
PART SEVEN CDO Equity	345	(34)
Why Buy CDO Equity?	347	(14)
Nonrecourse Term Financing	347	(7)
The Forgiving Nature of CDO Financing	354	(2)
CDO Options	356	(3)
CDO Equity as a Defensive Strategy	359	(1)
Conclusion	360	(1)
CDO Equity Returns and Return Correlation	361	(18)
Flawed Methodologies	362	(3)
The Appropriate Lesson from History	365	(2)
Loan Defaults and Recoveries	367	(3)
Cash Flow Modeling Defaults and Recoveries	370	(1)
Structured Finance Defaults and Recoveries	371	(1)
SF CDO Cash Flow Modeling	372	(2)
Return Correlation and Nonrecourse Leverage	374	(4)
Conclusion	378	(1)
PART EIGHT Other CDO Topics	379	(98)
Analytical Challenges in Secondary CDO Market Trading	381	(30)
Important Developments: Spread Tightening, Increased Activity	382	(2)
Pitfalls in Secondary CDO Trading	384	(3)
Eight-Point Checklist in Evaluating a CDO in the Secondary Market	387	(21)
Prescription for Making Primary Issuances Conducive to Secondary Trading	408	(1)
Conclusion	409	(2)
The CDO Arbitrage	411	(16)
Building Blocks	411	(11)
Impact of CDO Arbitrage on Structure	422	(3)
Conclusion	425	(2)
How to Evaluate a CDO and Manage a CDO Portfolio	427	(8)
Incentive Clashes in CDO Structures	427	(1)
Evaluate Structural Enhancements	428	(1)
Evaluating the Manager's Track Record	429	(5)
Conclusion	434	(1)
Quantifying Single-Name Risk Across CDOs	435	(18)
Collateral Overlap in U.S. CLOs	436	(1)
Favorite CLO Credits	437	(2)
Collateral Overlap in U.S. Structured Finance CDOs	439	(2)
Single-Name Risk and Tranche Protections	441	(2)
Excess Overcollateralization and Excess Overcollateralization Delta	443	(3)
Monte Carlo Simulation of Single Credit Risk	446	(3)
Comparing the Two Approaches	449	(1)
Conclusion	450	(3)
CDO Rating Experience	453	(24)
CDO Rating Downgrade Data	454	(2)
CDO and Tranche Rating Downgrade Frequency	456	(2)
CDO Downgrade Patterns	458	(2)
Why Downgrade Patterns?	460	(2)
Downgrade Severity	462	(2)
Downgrades of Aaa CDO Tranches	464	(1)
Extreme Rating Downgrades	464	(5)
CDO Defaults and Near Defaults	469	(4)
Conclusion	473	(4)
Index	477