Developments in Collateralized Debt Obligations: New Products and Insights

Preface xi

About the Authors xv

Part One Introduction 1

Chapter 1 Review of Collateralized Debt Obligations 3

Understanding CDOs 3

Cash Flow CDOs 10

Synthetic Arbitrage CDOs 28

Conclusion 37

Chapter 2 Impact of CDOs on Collateral Markets 39

Collateralized Loan Obligations and the High-Yield Bank Loan Market 39

Structured Finance CDOs and the Mezzanine Mortgage ABS Market 42

Trust Preferred Securities CDOs and their Collateral Market 46

Conclusion 48

Chapter 3 CDO Rating Experience 49

CDO Rating Downgrade Data 50

CDO and Tranche Rating Downgrade Frequency 52

CDO Downgrade Patterns 54

Why Downgrade Patterns? 56

Downgrade Severity 58

Extreme Rating Downgrades 58

CDO “Defaults” and Near “Defaults” 61

Summary 71

Part Two Developments in Synthetic CDOs 73

Chapter 4 ABS CDO Collateral Choices: Cash, ABCDS, and the ABX 75

Growth of the Subprime Synthetic Market 75

Importance of ABCDS to CDO Managers 76

ABCDS 79

The ABX Index 82

Fundamental Contractual Differences—Single-Name ABCDS/ABX Index/Cash 83

Supply/Demand Technicals 89

What Keeps the Arbitrage From Going Away? 92

Bottom Line—Buyers versus Sellers 94

The Cash/ABCDS Basis and the CDO Arbitrage 94

Single-Name ABCDS versus ABX in CDOs 96

Summary 97

Chapter 5 Hybrid Assets in an ABS CDO 99

Corporate CDS and ABCDS 100

Advantages of Hybrid Assets in an ABS CDO 103

Illustrative Hybrid ABS CDO Structure 105

Cash Flow Challenges 107

Conclusions 115

Chapter 6 Synthetic CDO Ratings 117

Tests of Index Portfolios 117

AAA Ratings and Expected Loss versus Default Probability 120

Barbell Portfolios 121

Summary 122

Chapter 7 Credit Default Swaps on CDOs 125

CDO CDS Nomenclature 126

CDO Credit Problems and their Consequences 127

Alternative Interest Cap Options 130

Miscellaneous Terms 133

Cash CDO versus CDO CDS 134

Exiting a CDO CDS 135

Rating Agency Concerns on CDOs that Sell Protection via CDO CDS 136

Summary 137

Part Three Emerging CDO Products 139

Chapter 8 Trust-Preferred CDOs 141

Trust-Preferred Securities 141

Other TruPS CDO Assets 144

TruPS CDO Issuance 144

Bank TruPS Prepayments and New CDO Issuance 147

TruPS CDO Structure 148

Assumptions Used by Rating Agencies 150

TruPS CDO Performance 161

TruPS Issuers and Issues 163

Summary 166

Chapter 9 Commercial Real Estate Primer 169

Loan Origination 170

Property-Level Loans 172

Commercial Mortgage-Backed Securities 178

REIT Securities 182

Evaluating CREL and CMBS 183

CREL Historical Performance 186

CMBS Historical Performance 197

Summary 203

Chapter 10 Commercial Real Estate CDOs 205

CRE CDO Defined 205

Market Trends 207

CRE Finance before CDOs 209

Types of CRE CDOs 210

CRE CDO Performance 211

Investors 212

CRE CDO Credit Analysis 214

Rating CRE CDOs 215

Summary 220

Chapter 11 CRE CDO Relative Value Methodology 221

Whole Loan CREL CDOs versus High-Yield CLOs 221

Investment-Grade CMBS CDOs versus Mezzanine Structured Finance CDOs 228

Relative Value among CRE CDOs 234

Summary 241

Part Four Other CDO Topics 243

Chapter 12 Rating Agency Research on CDOs 245

Using Rating Watches and Outlooks to Improve the Default Prediction Power of Ratings 245

Changes in Rating Methodologies 252

Conclusions 255

Chapter 13 Collateral Overlap and Single-Name Exposure in CLO Portfolios 257

Collateral Overlap in U.S. CLOs 258

Favorite CLO Credits 263

Single-Name Risk and Tranche Protections 265

Excess Overcollateralization and Excess Overcollateralization Delta 266

Summary 272

Index 275