Structured Finance and Collateralized Debt Obligations : New Developments in Cash and Synthetic Securitization

by Tavakoli, Janet M.

• ISBN13: 9780470288948
• ISBN10: 0470288949
• Edition: 2nd
• Format: Hardcover
• Copyright: 2008-09-16
• Publisher: Wiley

Summary

Praise for Structured Finance & Collateralized Debt Obligations Second Edition"Janet Tavakoli warned the world this disaster was coming well in advance. Now she explains it again for those who did not listen before as well as why it is not over yet. You need to read this book to understand the biggest credit bubble in world history." --Jim Rogers, author of A Bull in China, Hot Commodities, Adventure Capitalist, and Investment Biker"Janet Tavakoli's new book provides an insider view into the opaque world of structured finance and collateralized debt obligations. With its clear explanations of numerous structured-finance innovations, I expect this book to become the 'Rosetta Stone' for deciphering these markets. This book is a service to the investment community." --Hilary Till, Cofounder, Premia Capital Management, LLC"Janet Tavakoli explains the complex world of structured finance with unusual flair and colorful anecdotes from securitization's front lines. An indispensable and up-to-date guide for anyone seeking greater understanding of the CDO market." --Charles C. Henneman, CFA, Head, Educational Programs and Events, CFA Institute"Janet Tavakoli has been able to dissect, with a brisk style, the intricacies of many structured products. Not only does she explain in a clear and insightful manner how certain things work, but more important, why others do not work!" --Arturo Cifuentes, PhD, Managing Director, R.W. Pressprich & Co."Stan O'Neal, Marcus Ospel, and more than a few other bold-face names in finance might still have jobs if they'd taken the trouble to read this book. Janet Tavakoli takes the complexities of today's derivatives markets and makes them both comprehensible and digestible for everybody from the practitioner to the interested observer." --Greg Newton, Founding Publisher, MAR/Hedge"Janet Tavakoli is exceptional in having worked extensively both in mortgage securitization and structured credit at major financial institutions. In this clearly written book, she shares her in-depth knowledge of structuring, valuation, and risk management of structured products. This book is a must read for regulators and risk managers to keep up with the latest developments in structured finance." --Joseph Masri, PhD, Barclays Global Investors, Regional Director, Professional Risk Managers' International Association (PRMIA)

Author Biography

Janet M.Tavakoli is the President of Tavakoli Structured Finance, a Chicago-based consulting firm to financial institutions, institutional investors, and hedge funds. She gave advance warning of major collapses regarding Long-Term Capital Managment, First Alliance Mortgage, the thrift industry, and the current credit bubble. BusinessWeek's profile called Tavakoli "The Cassandra of Credit Derivatives." She has over twenty years of experience trading, structuring, and marketing derivatives and structured products. Tavakoli is a former adjunct associate professor in the FinanceDepartment of the University of Chicago's Graduate School of Business, where she taught derivatives. She is also the author of the first edition of Collateralized Debt Obligations and Structured Finance and Credit Derivatives and Synthetic Structures, now in its second edition. Tavakoli is frequently published and quoted in numerous financial publications including the Wall StreetJournal, the Financial Times, BusinessWeek, Journal of Structured Finance, Derivatives Week, and many others. She also appears frequently on CNN, CNBC, CBS Evening News, Bloomberg TV, and First Business Morning News.

Table of Contents

Preface	p. xiii
Acronym Key	p. xix
Securitization Terminology	p. 1
Simplified Cash CDO	p. 4
The CDO Arbitrage	p. 5
Structured Finance and Special Purpose Entities	p. 7
SPCs and Historical Abuse	p. 10
SPEs and SPVs	p. 16
Documentation	p. 18
Setup Costs	p. 19
Example of a Multiple Issuance Entity	p. 19
Cayman-Domiciled SPEs	p. 22
Repackagings to Satisfy Investor Demand	p. 24
Credit-Linked Notes and Funding Costs	p. 25
Structured Floaters	p. 27
Principal-Protected Notes	p. 27
Loan Repackagings	p. 28
Liquidity	p. 29
Mismatched Maturities	p. 29
Unwind Triggers Linked to Derivatives Transactions	p. 30
DAX-Linked Note with Triggers	p. 32
Ratings	p. 34
Master Trusts	p. 34
Owner Trusts	p. 35
Grantor Trusts	p. 36
Real Estate Mortgage Investment Conduits	p. 36
Multiseller and Single-Seller Conduits	p. 37
Domestically Domiciled Corporations	p. 39
Bankruptcy-Remote?	p. 40
Enron, JPMorgan Chase, and Sureties	p. 43
Credit Derivatives and Total Rate of Return Swaps	p. 45
Risk to Portfolio Value	p. 45
Credit Derivatives and Credit Default Swaps	p. 47
Negotiated Language	p. 49
Basis Risk: Persistent CDS Language Issues	p. 49
Physical Settlement and Cash Settlement Negotiations	p. 50
Digital, Binary, Zero-One, All-or-Nothing, or Fixed Recovery Cash Settlement	p. 52
Initial Value x (Par - Market Value)	p. 53
Normalized Price Method-Alternate Termination Payment	p. 54
Hedge Costs in Cash and Synthetic CDOs	p. 55
Deliverables: CDOs and the Cheapest-to-Deliver Option	p. 55
Convertible Bonds and Asset Swaps	p. 56
Negative Basis Trades	p. 62
Default and Recovery Rate	p. 62
The Default Protection Seller: Counterparty Credit and Correlation	p. 65
Default Language for Sovereign Debt	p. 65
Default Language for Nonsovereign Debt: Controversy and CDOs	p. 66
CDS Pricing Issues	p. 69
Synthetic CDOs	p. 70
Total Rate of Return Swaps (Total Return Swaps)	p. 72
Pricing TRORS on Levered CDO Tranches	p. 74
TRORS versus Repos	p. 75
Equity TRORS: Corporate Loans Disguised as Capital Injections	p. 76
Information Asymmetry and Moral Hazard	p. 78
CDS versus TRORS	p. 78
Pay-as-You-Go	p. 79
Indexes	p. 81
CDOs and the Global Capital Markets	p. 83
Evolution of the CDO Market	p. 84
Risk and Valuation Issues	p. 91
The Portfolio Diversification Myth	p. 91
Modern Portfolio Theory: Bane of CDOs	p. 92
Abnormal Is Normal	p. 96
Mark-to-Market Hazard	p. 98
Cash Flow Hazard	p. 99
Global Derivatives Risk	p. 100
Loans and Leveraged Loans	p. 101
The Leverage Paradox	p. 103
New Structured Finance Deals	p. 104
Fraud	p. 104
Hedge Funds: A New Investor Class	p. 107
Tavakoli's Law, Hedge Funds, and the Great Unwind	p. 110
Brain Damage Theory	p. 112
Dead Man's Curve and Leveraged Funds	p. 113
Margin of Safety versus One-Sided Illiquid Leveraged Bets	p. 114
Early CDO Technology	p. 117
True Sale Hybrid and Synthetic Structures	p. 117
Credit Enhancement	p. 119
Monoline and Multiline Insurance	p. 119
CDO Classification	p. 121
Market Value CDOs	p. 124
Cash Flow CDOs	p. 124
The Origins of U.S. Securitization	p. 126
Collateralized Mortgage Obligations	p. 135
Early Warning Commercial Financial Services	p. 143
Rating Agencies' Failed Models	p. 143
Anatomy of a Flawed Process	p. 144
Terminology	p. 145
Early Red Flags	p. 147
CFS Gets Creative	p. 149
Selling Out the Future	p. 149
Ignoring an Audit Report	p. 150
Lessons to Be Learned	p. 151
Fallout from CFS's Bankruptcy	p. 153
Subprime and Alt-A Mortgages: Collateral Damage	p. 155
Truthiness in Lending and Borrowing	p. 158
The Predators Fall	p. 160
Classic Ponzi Scheme	p. 162
Portfolio Risk	p. 164
The Risk Managers' Dilemma	p. 164
How to Create a Securitization Disaster	p. 165
Models versus Common Sense	p. 167
Lack of Appropriate Due Diligence and/or Disclosure	p. 172
Investors and Ratings	p. 173
Hedge Funds and ABX Indexes: Alpha Bets	p. 174
A Good Year (for Some)	p. 177
BSAM's Hedge Funds Undone by Leverage	p. 181
Bear Stearns' Hedge Fund Lenders Bailout	p. 184
Disclosure: Investor Fallout from the Mortgage Debacle	p. 186
"The First Thing We Do, Let's Kill All the Lawyers"	p. 188
Market Fallout from the Mortgage Debacle	p. 190
Redlining and Red Ink	p. 191
Cash versus Synthetic Arbitrage CDOs	p. 193
Comparison of Managed Arbitrage CDO Features: Cash versus Synthetic Deals	p. 193
The Arranger and the Manager	p. 195
Mandate Agreement	p. 196
Deal Assembly	p. 197
CDS Language for the Synthetic CDO	p. 197
Selecting the Portfolio and Impact on Rating	p. 198
Rating Criteria and Restrictions	p. 199
Substitution and Reinvestment Criteria	p. 207
Warehousing Assets	p. 207
Pricing and Closing	p. 208
Ramping Up the Portfolio	p. 208
Reinvestment Period	p. 209
Noncall Period	p. 209
Pay-Down Period	p. 210
Weighted Average Life and Expected Final Maturity	p. 210
Early Termination	p. 210
Legal Final Maturity	p. 211
Tranching and the Synthetic Arbitrage Advantage	p. 211
Waterfalls for Cash versus Synthetic Arbitrage CDOs	p. 212
Payment-in-Kind Tranches	p. 218
Psychic Ratings: Rating Agency Treatment of PIK Tranches	p. 218
The Super Senior Advantage	p. 219
CDS versus Cash Asset Spreads	p. 220
Hedging the CDO Portfolio Cash Flows	p. 226
Settlement in Event of Default or Credit Event	p. 233
Documentation	p. 236
Cash versus Synthetic Arbitrage CDO Equity Cash Flows	p. 236
Sample Cash Flows	p. 237
Summary of Cash Arbitrage CDOs versus Synthetic Arbitrage CDOs	p. 246
CDO Equity Structures	p. 247
Accruing Errors	p. 250
Probability of Receipt	p. 253
The Best and Worst Equity Investments	p. 254
The Best Equity Earns All Residuals	p. 256
Equity Investor Injects Cash as Overcollateralization	p. 257
Rated Equity Earns Stated Coupon Appropriate to Rating	p. 259
Rated Equity: Static Deal	p. 260
Equity Investor Earns a Stated Coupon on the Remaining Equity Investment	p. 262
Moral Hazard and Conflict of Interest	p. 268
Leveraging the Best: Unfunded Equity Investments-Ultimate Leverage	p. 270
Actively Traded and Limited Substitution Synthetic Arbitrage CDOs	p. 273
Interest Subparticipations: When Equity Isn't First Loss	p. 273
Participation Notes	p. 276
Capped Participation Notes	p. 278
Combination Notes	p. 278
Investor Motivation	p. 279
Principal-Protected Structures	p. 280
First- (and nth-) to-Default Basket Swaps	p. 282
First-to-Default Notes	p. 290
The Smartest Equity Investment: Protection Money	p. 290
CDO Managers	p. 291
Best Practices	p. 292
The Valued Few	p. 293
Balance-Sheet CLOs and CDOs	p. 295
True Sale (Fully Funded): Delinked Structure	p. 295
Linked Nonsynthetic Structures	p. 299
Linked Black-Box CLN CDOs	p. 301
Synthetic Structure with SPE	p. 304
Partially Synthetic Linked CDOs	p. 307
Fully Synthetic CDOs	p. 308
Small to Medium-Size Enterprises-Europe	p. 310
SMEs: United States versus Europe	p. 315
Secured Loan Trusts	p. 318
Bank Regulatory Capital and Basel II	p. 321
Super Senior Sophistry	p. 331
Cash Flow Magic Trick	p. 333
Rating Agencies-Moody's Tranching	p. 334
The AAA Disappearing Act	p. 337
Rating Agencies and Ratings Shopping	p. 338
Triple-A Basket with 2 Percent First-Loss Tranche	p. 340
Super Senior Attachment Point	p. 341
Super Senior Pricing	p. 342
Super Seniors or Senile Seniors?	p. 343
Where Are the Regulators?	p. 345
Junior Super Seniors	p. 346
Super Senior Investors	p. 347
Negative Basis Trades	p. 348
Leveraged Super Seniors and Constant Proportion Portfolio Insurance	p. 349
Final Thoughts on Super Seniors	p. 350
Synthetics and Mark-to-Market Issues	p. 353
Synthetic Cash Windfall	p. 353
Synthetic Equity	p. 354
Portfolio Swaps	p. 356
Bespoke Tranches: Single-Tranche CDOs	p. 357
Short Mezzanine and Long Equity	p. 359
Banks' Invisible Hedge Funds	p. 365
Extraordinary Popular Delusions and the Madness of Correlation	p. 365
Delta Hedges, Correlation Models, and Junk Science	p. 367
Synthetic Notional and Actual Risk	p. 369
Explosive Growth, Uncertain Future	p. 370
Found Money and Moral Hazard	p. 371
Comments on Selected Structured Finance Products	p. 373
Multisector CDOs: CDOs[superscript N]	p. 373
Future Flows: Payment Rights Securitizations	p. 374
Emerging Market Caveats	p. 379
Constant Proportion Debt Obligations and Rating Agencies	p. 382
Constant Proportion Portfolio Insurance	p. 384
Multiline Insurance Products: Disappointment and Promise	p. 384
Hollywood Funding	p. 386
Transformers	p. 388
SEC Gaslight on Life Settlements	p. 390
Special Purpose Acquisition Companies	p. 394
Credit Funds	p. 397
Credit Hedge Funds	p. 397
Hedge Funds and Structured Credit	p. 398
IO and PO Tranches: Junior Tranches and Equity OIDs	p. 399
Limited Purpose Finance Corporations	p. 399
Structured Investment Vehicles	p. 401
Credit Derivative Product Companies	p. 402
Hedge Funds and Collateralized Fund Obligations	p. 403
The Credit Crunch and CDOs	p. 405
Rating Agencies, Regulators, and Junk Science	p. 405
Savvy Investors Ignore Ratings	p. 407
Misfortune's Formula: Structured Credit Ratings	p. 408
ABCP Crisis and MLEC	p. 412
Constellation CDOs: Falling Stars	p. 413
New Flawed Models Replace Old Flawed Models	p. 415
Rating Agencies in Crisis	p. 415
Monoline Meltdown: Financial Guarantors in Crisis	p. 417
Rating Agencies in Denial	p. 418
Overwhelming Losses	p. 419
Poor Actual Recoveries	p. 420
Undercapitalized Financial Guarantors	p. 422
Dicey Deals Done Dirt Cheap	p. 422
Competitive Pressure	p. 425
Uncertain Future	p. 425
Countrywide's Bailout and Moral Hazard	p. 426
Future Developments in Structured Finance	p. 429
Regulatory Failure: Investors Are on Their Own	p. 430
Interesting Web Sites	p. 435
Bibliography	p. 437
Index	p. 439
Table of Contents provided by Ingram. All Rights Reserved.