Developments in Collateralized Debt Obligations

DOUGLAS J. LUCAS is Executive Director at UBS and head of CDO research. He has an MBA from the University of Chicago. LAURIE S. GOODMAN, PHD, is co-Head of Global Fixed Income Research at UBS. She holds a PhD in economics from Stanford University. FRANK J. FABOZZI, PHD, CFA, is Professor in the Practice of Finance at Yale University's School of Management and the Editor of the Journal of Portfolio Management. REBECCA J. MANNING is an Associate Director in the CDO Research Group at UBS. She holds an MBA from The Wharton School at the University of Pennsylvania.

• Preface xiAbout the Authors xvPart One Introduction 1Chapter 1 Review of Collateralized Debt Obligations 3Understanding CDOs 3Cash Flow CDOs 10Synthetic Arbitrage CDOs 28Conclusion 37Chapter 2 Impact of CDOs on Collateral Markets 39Collateralized Loan Obligations and the High-Yield Bank Loan Market 39Structured Finance CDOs and the Mezzanine Mortgage ABS Market 42Trust Preferred Securities CDOs and their Collateral Market 46Conclusion 48Chapter 3 CDO Rating Experience 49CDO Rating Downgrade Data 50CDO and Tranche Rating Downgrade Frequency 52CDO Downgrade Patterns 54Why Downgrade Patterns? 56Downgrade Severity 58Extreme Rating Downgrades 58CDO “Defaults” and Near “Defaults” 61Summary 71Part Two Developments in Synthetic CDOs 73Chapter 4 ABS CDO Collateral Choices: Cash, ABCDS, and the ABX 75Growth of the Subprime Synthetic Market 75Importance of ABCDS to CDO Managers 76ABCDS 79The ABX Index 82Fundamental Contractual Differences—Single-Name ABCDS/ABX Index/Cash 83Supply/Demand Technicals 89What Keeps the Arbitrage From Going Away? 92Bottom Line—Buyers versus Sellers 94The Cash/ABCDS Basis and the CDO Arbitrage 94Single-Name ABCDS versus ABX in CDOs 96Summary 97Chapter 5 Hybrid Assets in an ABS CDO 99Corporate CDS and ABCDS 100Advantages of Hybrid Assets in an ABS CDO 103Illustrative Hybrid ABS CDO Structure 105Cash Flow Challenges 107Conclusions 115Chapter 6 Synthetic CDO Ratings 117Tests of Index Portfolios 117AAA Ratings and Expected Loss versus Default Probability 120Barbell Portfolios 121Summary 122Chapter 7 Credit Default Swaps on CDOs 125CDO CDS Nomenclature 126CDO Credit Problems and their Consequences 127Alternative Interest Cap Options 130Miscellaneous Terms 133Cash CDO versus CDO CDS 134Exiting a CDO CDS 135Rating Agency Concerns on CDOs that Sell Protection via CDO CDS 136Summary 137Part Three Emerging CDO Products 139Chapter 8 Trust-Preferred CDOs 141Trust-Preferred Securities 141Other TruPS CDO Assets 144TruPS CDO Issuance 144Bank TruPS Prepayments and New CDO Issuance 147TruPS CDO Structure 148Assumptions Used by Rating Agencies 150TruPS CDO Performance 161TruPS Issuers and Issues 163Summary 166Chapter 9 Commercial Real Estate Primer 169Loan Origination 170Property-Level Loans 172Commercial Mortgage-Backed Securities 178REIT Securities 182Evaluating CREL and CMBS 183CREL Historical Performance 186CMBS Historical Performance 197Summary 203Chapter 10 Commercial Real Estate CDOs 205CRE CDO Defined 205Market Trends 207CRE Finance before CDOs 209Types of CRE CDOs 210CRE CDO Performance 211Investors 212CRE CDO Credit Analysis 214Rating CRE CDOs 215Summary 220Chapter 11 CRE CDO Relative Value Methodology 221Whole Loan CREL CDOs versus High-Yield CLOs 221Investment-Grade CMBS CDOs versus Mezzanine Structured Finance CDOs 228Relative Value among CRE CDOs 234Summary 241Part Four Other CDO Topics 243Chapter 12 Rating Agency Research on CDOs 245Using Rating Watches and Outlooks to Improve the Default Prediction Power of Ratings 245Changes in Rating Methodologies 252Conclusions 255Chapter 13 Collateral Overlap and Single-Name Exposure in CLO Portfolios 257Collateral Overlap in U.S. CLOs 258Favorite CLO Credits 263Single-Name Risk and Tranche Protections 265Excess Overcollateralization and Excess Overcollateralization Delta 266Summary 272Index 275