introduction toc dos

7/31/2019 Introduction Toc Dos

1/26

Copyright 2010, 2011 by Neil D.Pearson. All rights reserved.

CDOs, Especially CDOs of RMBS

Neil D. Pearson


2/26

Various Types of CDOs

CDOs of corporates:

cash CDOs

Collateralized loan obligations (CLOs)

Synthetic CDOs

Single-tranche synthetic CDOs

ABS CDOs; collateral can include: Tranches of subprime RMBS

Tranches of Alt-A or jumbo prime RMBS

CMBS

Tranches of credit card ABS, auto loan ABS, Tranches of other CDOs

Others

There are also some other kinds, e.g. CDOs of trust preferred

securities (TRPS)Copyright 2010, 2011 by Neil D. Pearson. Allrights reserved.


3/26

Copyright 2010, 2011 by Neil D. Pearson. Allrights reserved.

CDO of Corporates

Bond

55

Bond

77

Bond

78

AAA

Bond

AA

Bond

A

Bond

BBB

Bond

BBB-

Bond

Residual

CDO

Bonds

CDO Assets

CDO

Assets

Bond111

Bond

112

Bond

113

Bond

114

Bond115

Bond

116

Bond

117

Bond

118

Bond119

Bond

120

Bond

1

Bond2

Bond3

Bond

4

Bond

5Bond

6

Bond

7

Bond

8

Bond

9

Bond

10

Bond101

Bond

102

Bond

103

Bond104

Bond105

Bond

106

Bond107

Bond

108

Bond109

Bond110

Bond11

Bond12

Bond13

Bond

14

Bond15

Bond16

Bond

17

Bond

18

Bond19

Bond20

Bond

31

Bond

22

Bond

24

Bond24

Bond

25Bond

26

Bond27

Bond28

Bond

29

Bond

30

Bond

31

Bond32

Bond33

Bond

34

Bond

35Bond

36

Bond

37

Bond

38

Bond

39

Bond

40

Bond41

Bond42

Bond43

Bond

44

Bond

45Bond

46

Bond

47

Bond

48

Bond

49

Bond40

Bond

51

Bond52

Bond53

Bond

54Bond

56

Bond

57

Bond

58

Bond

59

Bond

60

Bond71

Bond

72

Bond

73

Bond

74

Bond

75Bond

76

Bond

79

Bond80

Bond

81

Bond

82

Bond

83

Bond84

Bond

85Bond

86

Bond87

Bond1298

Bond

89

Bond

90

Bond91

Bond

92

Bond

93

Bond

94

Bond

95Bond

96

Bond

97

Bond

98

Bond

99

Bond100

Special Purpose VehicleIn a cash collateralized debt

obligation (CDO) based on

corporate bonds, the sponsor

assembles a portfolio of

corporate bonds, which

comprise the assets of a

special purpose vehicle. The

SPV then issues various CDO

bonds. The SPV has a set ofrules according to which the

interest and principal cash

flows from the CDO assets

are distributed to the various

CDO bonds. In this set of

rules, the higher-rated CDO

bonds will have first claim on

the cash flows, while the

lower-rated CDO Bonds will

bear most of the default risk.Another name for a CDO

bond is a tranche


4/26


CDO of Corporates

Bond

55

Bond

77

Bond

78

AAA

Bond

AA

Bond

A

Bond

BBB

Bond

BBB-

Bond

Residual

CDO

Bonds

CDO Assets

CDO

Assets

Bond111

Bond

112

Bond

113

Bond

114

Bond115

Bond

116

Bond

117

Bond

118

Bond119

Bond

120

Bond

1

Bond2

Bond3

Bond

4

Bond

5Bond

6

Bond

7

Bond

8

Bond

9

Bond

10

Bond101

Bond

102

Bond

103

Bond104

Bond105

Bond

106

Bond107

Bond

108

Bond109

Bond110

Bond11

Bond12

Bond13

Bond

14

Bond15

Bond16

Bond

17

Bond

18

Bond19

Bond20

Bond

31

Bond

22

Bond

24

Bond24

Bond

25Bond

26

Bond27

Bond28

Bond

29

Bond

30

Bond

31

Bond32

Bond33

Bond

34

Bond

35Bond

36

Bond

37

Bond

38

Bond

39

Bond

40

Bond41

Bond42

Bond43

Bond

44

Bond

45Bond

46

Bond

47

Bond

48

Bond

49

Bond40

Bond

51

Bond52

Bond53

Bond

54Bond

56

Bond

57

Bond

58

Bond

59

Bond

60

Bond71

Bond

72

Bond

73

Bond

74

Bond

75Bond

76

Bond

79

Bond80

Bond

81

Bond

82

Bond

83

Bond84

Bond

85Bond

86

Bond87

Bond1298

Bond

89

Bond

90

Bond91

Bond

92

Bond

93

Bond

94

Bond

95Bond

96

Bond

97

Bond

98

Bond

99

Bond100

Special Purpose VehicleIf a few bonds default, the

residual or equity tranche

bears the losses


5/26


CDO of Corporates

Bond

55

Bond

77

Bond

78

AAA

Loan

AA

Bond

A

Loan

BBB

Bond

BBB-

Bond

Residual

CDO

Bonds

CDO Assets

CDO

Assets

Bond111

Bond

112

Bond

113

Bond

114

Bond115

Bond

116

Bond

117

Bond

118

Bond119

Bond

120

Bond

1

Bond2

Bond3

Bond

4

Bond

5Bond

6

Bond

7

Bond

8

Bond

9

Bond

10

Bond101

Bond

102

Bond

103

Bond104

Bond105

Bond

106

Bond107

Bond

108

Bond109

Bond110

Bond11

Bond12

Bond13

Bond

14

Bond15

Bond16

Bond

17

Bond

18

Bond19

Bond20

Bond

31

Bond

22

Bond

24

Bond24

Bond

25Bond

26

Bond27

Bond28

Bond

29

Bond

30

Bond

31

Bond32

Bond33

Bond

34

Bond

35Bond

36

Bond

37

Bond

38

Bond

39

Bond

40

Bond41

Bond42

Bond43

Bond

44

Bond

45Bond

46

Bond

47

Bond

48

Bond

49

Bond40

Bond

51

Bond52

Bond53

Bond

54Bond

56

Bond

57

Bond

58

Bond

59

Bond

60

Bond71

Bond

72

Bond

73

Bond

74

Bond

75Bond

76

Bond

79

Bond80

Bond

81

Bond

82

Bond

83

Bond84

Bond

85Bond

86

Bond87

Bond1298

Bond

89

Bond

90

Bond91

Bond

92

Bond

93

Bond

94

Bond

95Bond

96

Bond

97

Bond

98

Bond

99

Bond100

Special Purpose VehicleIf a few bonds default, the

residual or equity tranche

bears the losses.

If more bonds default, the

BBB- and BBB CDO bonds

will suffer losses

And if yet more bonds in the

collateral pool default, the A

and AA CDO bonds mightsuffer losses


6/26


Collateralized Loan Obligation (CLO)

Loan

55

Loan

77

Loan

78

AAA

Bonds

AA

Bond

A

Bond

BBB

Bond

BBB-

Bond

Residual

CLO

Bonds

CLO Assets

CLO

Assets

Loan111

Loan

112

Loan

113

Loan

114

Loan115

Loan

116

Loan

117

Loan

118

Loan119

Loan

120

Loan

1

Loan2

Loan3

Loan

4

Loan

5Loan

6

Loan

7

Loan

8

Loan

9

Loan

10

Loan101

Loan

102

Loan

103

Loan104

Loan105

Loan

106

Loan107

Loan

108

Loan109

Loan110

Loan11

Loan12

Loan13

Loan

14

Loan15

Loan16

Loan

17

Loan

18

Loan19

Loan20

Loan

31

Loan

22

Loan

24

Loan24

Loan

25Loan

26

Loan27

Loan28

Loan

29

Loan

30

Loan

31

Loan32

Loan33

Loan

34

Loan

35Loan

36

Loan

37

Loan

38

Loan

39

Loan

40

Loan41

Loan42

Loan43

Loan

44

Loan

45Loan

46

Loan

47

Loan

48

Loan

49

Loan40

Loan

51

Loan52

Loan53

Loan

54Loan

56

Loan

57

Loan

58

Loan

59

Loan

60

Loan71

Loan

72

Loan

73

Loan

74

Loan

75Loan

76

Loan

79

Loan80

Loan

81

Loan

82

Loan

83

Loan84

Loan

85Loan

86

Loan87

Loan1298

Loan

89

Loan

90

Loan91

Loan

92

Loan

93

Loan

94

Loan

95Loan

96

Loan

97

Loan

98

Loan

99

Loan100

Special Purpose VehicleA collateralized loan

obligation (CLO) has a

collateral pool consisting of

leveraged loans, not bond.

Because leveraged loans

amortize relatively quickly,

many CLOs will reinvest the

amortization in additional

leveraged loans for someperiod of time.


7/26


Synthetic CDO (of Corporates)

CDS

55

AAA

Bond

AA

Bond

A

Bond

BBB

Bond

BBB-

Bond

Residual

CDOLiabilities

CDOcollateral pool

CDO

Collateral

Pool

CDS

111

CDS112

CDS113

CDS

114

CDS

115CDS116

CDS

117

CDS

118

CDS

119

CDS120

CDS

1

CDS2

CDS3

CDS

4

CDS

5CDS

6

CDS

7

CDS

8

CDS

9

CDS

10

CDS

101

CDS

102

CDS

103

CDS

104

CDS

105CDS

106

CDS

107CDS

108

CDS

109

CDS

110

CDS11

CDS12

CDS13

CDS

14

CDS15

CDS16

CDS

17

CDS

18

CDS19

CDS20

CDS

31

CDS

22

CDS

24

CDS24

CDS

25CDS

26

CDS27

CDS28

CDS

29

CDS

30

CDS

31

CDS32

CDS33

CDS

34

CDS

35CDS

36

CDS

37

CDS

38

CDS

39

CDS

40

CDS41

CDS42

CDS43

CDS

44

CDS

45CDS

46

CDS

47

CDS

48

CDS

49

CDS40

CDS

51

CDS52

CDS53

CDS

54CDS

56

CDS

57

CDS

58

CDS

59

CDS

60

CDS

81

CDS

82

CDS

83

CDS84

CDS

85CDS

86

CDS87

CDS1298

CDS

89

CDS

90

CDS

91

CDS92

CDS93

CDS94

CDS95

CDS96

CDS97

CDS98

CDS99

CDS

100

In a synthetic CDO the

collateral pool consists of a

portfolio of CDS, not bonds,

and cash often invested in a

Guaranteed Investment

Contract issued by an

insurance company.

The CDS and cash together

create a synthetic bondportfolio.

Cash

Special Purpose Vehicle


8/26


Synthetic CDO (of Corporates)

CDS

55

Loan

77

CDS

78

AAA

Tranche

AA

Tranche

A

Tranche

BBB

Tranche

BBB-

Tranche

Tranche

CDOLiabilities

CDOcollateral pool

CDO

Collateral

Pool

CDS111

CDS

112

CDS

113

CDS

114

Loan115

CDS

116

CDS

117

CDS

118

CDS119

CDS

120

CDS

1

CDS2

CDS3

CDS

4

CDS

5CDS

6

CDS

7

CDS

8

CDS

9

CDS

10

CDS101

CDS

102

CDS

103

CDS104

CDS105

CDS

106

CDS107

CDS

108

CDS109

CDS110

CDS11

CDS12

CDS13

CDS

14

CDS15

CDS16

CDS

17

CDS

18

CDS19

CDS20

CDS

31

CDS

22

CDS

24

CDS24

CDS

25CDS

26

CDS27

CDS28

CDS

29

CDS

30

CDS

31

CDS32

CDS33

CDS

34

CDS

35CDS

36

CDS

37

CDS

38

CDS

39

CDS

40

CDS41

CDS42

CDS43

CDS

44

CDS

45CDS

46

CDS

47

CDS

48

CDS

49

CDS40

CDS

51

CDS52

CDS53

CDS

54CDS

56

CDS

57

CDS

58

CDS

59

CDS

60

CDS71

CDS

72

CDS

73

CDS

74

CDS

75CDS

76

CDS

79

CDS80

CDS

81

CDS

82

CDS

83

CDS84

CDS

85CDS

86

CDS87

CDS1298

CDS

89

CDS

90

CDS91

CDS

92

CDS

93

CDS

94

CDS

95CDS

96

CDS

97

CDS

98

CDS

99

CDS100

The collateral pool need not

include any cash---it might

consist only of CDS. In this

case the CDO is just a

complicated credit default

swap, and the liabilities are

legs of the swap


9/26

Synthetic CDO

Collateral Pool CDO Tranches

100+ CDS on

corporates

Most senior

tranche

Next tranche

Swap Documentation

Next tranche

Next tranche

Next tranche

CDO tranches pay

a portion of the

losses on the

collateral pool

CDO tranches

receive premiums



10/26

Single-Tranche Synthetic CDO

100+ CDS on

corporates

CDO tranche

If it is a swap, then one does not need the full capitalstructure. In a single-tranche synthetic CDO, the

protection seller receives a premium in exchange

for covering a portion of the losses on the collateral

pool. The protection buyer pays the premium, and

receives the protection payments.

CDO tranche pay

a portion of the

losses on the

collateral pool

CDO tranche

receive premiums

Protection Seller

Protection Buyer



11/26

Synthetic CDO of Corporates

The attachment and detachment points indicate theportions of the losses for which each tranche is responsible


Collateral Pool

Notional

Attachment

Point (%)

Detachment

Point (%)

Attachment

Point ($)

Detachment

Point ($)

Tranche

Notional

Coupon

(Spread)1,000,000,000 0% 3% 0 30,000,000 30,000,000 15.000%

1,000,000,000 3% 7% 30,000,000 70,000,000 40,000,000 4.000%

1,000,000,000 7% 10% 70,000,000 100,000,000 30,000,000 3.000%

1,000,000,000 10% 15% 100,000,000 150,000,000 50,000,000 1.400%

1,000,000,000 15% 30% 150,000,000 300,000,000 150,000,000 0.350%

Description of the CDO Tranches


12/26

ABS CDOs

Now lets consider CDOs of asset-backed securities, calledABS CDOs.

In an ABS CDO,

collateral pool consists of bonds issued by an asset securitization

commonly, the ultimate underlying asset are subprime mortgages,and the bonds are subprime residential mortgage-backed securities

(subprime RMBS)

First need to consider the lower-level asset securitization



13/26

Copyright 2010, 2011 by Neil D. Pearson. All

rights reserved.

Asset (Mortgage) Securitization

Mortgage

55

Mrtg

77

Mortgage

78

AAA

Bond

AA

Bond

A

Bond

BBB

Bond

BBB-

Bond

Residual

Asset-Backed

Securities

Assets(Mortgages)

Assets of

the SPV

Mrtg1991

Motg

1992

Mrtg

1993

Mrtg

1994

Mrtg1995

Mrtg

1996

Mrtg

1997

Mrtg

1998

Mrtg1999

Mrtg

2000

Mrtg

1

Mrtg2

Mrtg3

Mrtg

4

Mrtg

5Mrtg

6

Mrtg

7

Mrtg

8

Mrtg

9

Mrtg

10

Mrtg101

Mrtg

102

Mrtg

103

Mrtg104

Mrtg105

Mrtg

106

Mrtg107

Mrtg

108

Mrtg109

Mrtg110

Mrtg11

Mrtg12

Mrtg13

Mrtg14

Mrtg15

Mrtg16

Mrtg17

Mrtg18

Mrtg19

Mrtg20

Mrtg

31

Mrtg

22

Mrtg

24

Mrtg24

Mrtg

25Mrtg

26

Mrtg27

Mrtg28

Mrtg

29

Mrtg

30

Mrtg

31

Mrtg32

Mrtg33

Mrtg

34

Mrtg

35Mrtg

36

Mrtg

37

Mrtg

38

Mrtg

39

Mrtg

40

Mrtg41

Mrtg42

Mrtg43

Mrtg

44

Mrtg

45Mrtg

46

Mrtg

47

Mrtg

48

Mrtg

49

Mrtg40

Mrtg

51

Mrtg52

Mrtg53

Mrtg

54Mrtg

56

Mrtg

57

Mrtg

58

Mrtg

59

Mrtg60

Mrtg

71

Mrtg

72

Mrtg

73

Mrtg

74

Mrtg

75Mrtg

76

Mrtg

79

Mrtg80

Mrtg

81

Mrtg

82

Mrtg

83

Mrtg84

Mrtg

85Mrtg

86

Mrtg87

Mrtg1298

Mrtg

89

Mrtg

90

Mrtg91

Mrtg

92

Mrtg

93

Mrtg

94

Mrtg

95Mrtg

96

Mrtg

97

Mrtg

98

Mrtg

99

Mrtg100

Special Purpose Vehicle In an asset securitization, the

sponsor assembles a portfolio

of assets, for example 2,000

or 3,000 home mortgages.

These mortgages comprise

the assets of a special purpose

vehicle. The SPV then issues

various bonds, called in this

case residential mortgage-backed securities. The SPV

has a set of rules according to

which the interest and

principal cash flows from the

assets are distributed to the

various bonds. In this set of

rules, the higher-rated bondswill have first claim on the

cash flows, while the lower-

rated bonds will bear most of

the default risk.


14/26


rights reserved.

Asset (Mortgage) Securitization

Mortgage55

Mrtg

77

Mortgage

78

AAA

Bond

AA

Bond

A

Bond

BBB

Bond

BBB-

Bond

Residual

Asset-Backed

Securities

Assets(Mortgages)

Assets of

the SPV

Mrtg1991

Motg

1992

Mrtg

1993

Mrtg

1994

Mrtg1995

Mrtg

1996

Mrtg

1997

Mrtg

1998

Mrtg1999

Mrtg

2000

Mrtg

1

Mrtg2

Mrtg3

Mrtg

4

Mrtg

5Mrtg

6

Mrtg

7

Mrtg

8

Mrtg

9

Mrtg

10

Mrtg101

Mrtg

102

Mrtg

103

Mrtg104

Mrtg105

Mrtg

106

Mrtg107

Mrtg

108

Mrtg109

Mrtg110

Mrtg11

Mrtg12

Mrtg13

Mrtg14

Mrtg15

Mrtg16

Mrtg17

Mrtg18

Mrtg19

Mrtg20

Mrtg

31

Mrtg

22

Mrtg

24

Mrtg24

Mrtg

25Mrtg

26

Mrtg27

Mrtg28

Mrtg

29

Mrtg

30

Mrtg

31

Mrtg32

Mrtg33

Mrtg

34

Mrtg

35Mrtg

36

Mrtg

37

Mrtg

38

Mrtg

39

Mrtg

40

Mrtg41

Mrtg42

Mrtg43

Mrtg

44

Mrtg

45Mrtg

46

Mrtg

47

Mrtg

48

Mrtg

49

Mrtg40

Mrtg

51

Mrtg52

Mrtg53

Mrtg

54Mrtg

56

Mrtg

57

Mrtg

58

Mrtg59

Mrtg60

Mrtg

71

Mrtg

72

Mrtg

73

Mrtg

74

Mrtg

75Mrtg

76

Mrtg

79

Mrtg80

Mrtg

81

Mrtg

82

Mrtg

83

Mrtg84

Mrtg

85Mrtg

86

Mrtg87

Mrtg1298

Mrtg

89

Mrtg

90

Mrtg91

Mrtg

92

Mrtg

93

Mrtg

94

Mrtg

95Mrtg

96

Mrtg

97

Mrtg

98

Mrtg

99

Mrtg100

Special Purpose Vehicle If the SPV assets are

mortgages, we call the bonds

issued by the SPV Residential

Mortgage-Backed Securities

(RMBS). If the SPV assets

are subprime mortgages, we

call the bond subprime

RMBS. If the SPV asset are

commercial mortgages, thenthe bonds are called

commercial mortgage-backed

securities (CMBS). If the SPV

assets are credit card

receivables, then the bonds

issued by the SPV are called

credit card asset-backedsecurities (ABS). Similarly

for other collateral categories,

e.g. we can have auto loan

ABS


15/26


rights reserved.

Asset (Mortgage) Securitization and ABS CDOs

Mortgage55

Mrtg

77

Mortgage

78

AAA

BOND

AA

Bond

A

Bond

BBB

Bond

BBB-

Bond

Residual

Asset-Backed

Securities

Assets(Mortgages)

Assets of

the SPV

Mrtg111

Motg

112

Mrtg

113

Mrtg

114

Mrtg115

Mrtg

116

Mrtg

117

Mrtg

118

Mrtg119

Mrtg

120

Mrtg

1

Mrtg2

Mrtg3

Mrtg

4

Mrtg

5Mrtg

6

Mrtg

7

Mrtg

8

Mrtg

9

Mrtg

10

Mrtg101

Mrtg

102

Mrtg

103

Mrtg104

Mrtg105

Mrtg

106

Mrtg107

Mrtg

108

Mrtg109

Mrtg110

Mrtg11

Mrtg12

Mrtg13

Mrtg14

Mrtg15

Mrtg16

Mrtg17

Mrtg18

Mrtg19

Mrtg20

Mrtg

31

Mrtg

22

Mrtg

24

Mrtg24

Mrtg

25Mrtg

26

Mrtg27

Mrtg28

Mrtg

29

Mrtg

30

Mrtg

31

Mrtg32

Mrtg33

Mrtg

34

Mrtg

35Mrtg

36

Mrtg

37

Mrtg

38

Mrtg

39

Mrtg

40

Mrtg41

Mrtg42

Mrtg43

Mrtg

44

Mrtg

45Mrtg

46

Mrtg

47

Mrtg

48

Mrtg

49

Mrtg40

Mrtg

51

Mrtg52

Mrtg53

Mrtg54

Mrtg56

Mrtg57

Mrtg58

Mrtg59

Mrtg60

Mrtg

71

Mrtg

72

Mrtg

73

Mrtg

74

Mrtg

75Mrtg

76

Mrtg

79

Mrtg80

Mrtg

81

Mrtg

82

Mrtg

83

Mrtg84

Mrtg

85Mrtg

86

Mrtg87

Mrtg1298

Mrtg

89

Mrtg

90

Mrtg91

Mrtg

92

Mrtg

93

Mrtg

94

Mrtg

95Mrtg

96

Mrtg

97

Mrtg

98

Mrtg

99

Mrtg100

Special Purpose Vehicle In an ABS CDO, the assets

of the CDO SPV are bondsissued by mortgage or

other asset securitization

For example, this BBB-bond might go into the

asset pool of an ABS CDO


16/26

AAA

Tranche

AA

Tranche

A

Tranche

BBBTranche

Equity

Tranche

CDO

Structure

Special

Purpose

Vehicle

CDO

Trust

Note Coupon

(L + bps)

Proceeds

($)

Bond Coupons

(L + bps)

Proceeds

($)

Reference Portfolio

Collateral Pool

ABS

Tranche 15

ABS

Tranche 14

ABS

Tranche 13

ABS

Tranche 12

ABS

Tranche 11

ABS

Tranche 10

ABS

Tranche 9

ABS

Tranche 8

ABS

Tranche 7

ABS

Tranche 6

ABS

Tranche 5

ABS

Tranche 4

ABS

Tranche 3

ABS

Tranche 2

ABS

Tranche 1

ABS

Tranche 20

ABS

Tranche 19

ABS

Tranche 18

ABS

Tranche 17

ABS

Tranche 16

ABS

Tranche 25

ABS

Tranche 24

ABS

Tranche 23

ABS

Tranche 22

ABS

Tranche 21

ABS

Tranche 90

ABS

Tranche 89

ABS

Tranche 88

ABS

Tranche 87

ABS

Tranche 86

ABSCDO

Tranche 10

ABSCDO

Tranche 9

ABSCDO

Tranche 8

ABSCDO

Tranche 7

ABSCDO

Tranche 6

ABSCDOTranche 5ABSCDOTranche 4ABSCDOTranche 3ABSCDOTranche 2ABSCDOTranche 1

ABS CDO

Mtge

995

Mtge

1197

Mtge

1198

AAA

RMBS

AA

RMBS

A

RMBS

BBB

RMBS

BBB-

RMBS

Residual

RMBS

Bonds

Special

Purpose

Vehicle

Assets

(Mortgages)

Mtge

1991

Mtge

1992

Mtge

1993

Mtge

1994

Mtge

1995Mtge

1996

Mtge

1997

Mtge

1998

Mtge

1999

Mtge

2000

Mtge1

Mtge2

Mtge3

Mtge4

Mtge5

Mtge6

Mtge7

Mtge8

Mtge9

Mtge10

Mtge

1791

Mtge1792

Mtge1793

Mtge

1794

Mtge

1795Mtge1796

Mtge

1797Mtge1798

Mtge

1799

Mtge

1800

Mtge

191

Mtge

192

Mtge

193

Mtge194

Mtge

195Mtge

196

Mtge197

Mtge198

Mtge

199

Mtge

200

Mtge

391

Mtge392

Mtge393

Mtge

394

Mtge

395Mtge396

Mtge

397

Mtge

398

Mtge

399

Mtge

400

Mtge591

Mtge

592

Mtge

593

Mtge

594

Mtge

595Mtge

596

Mtge

597

Mtge

598

Mtge

599

Mtge600

Mtge791 Mtge792 Mtge793 Mtge794 Mtge795 Mtge796 Mtge797 Mtge798 Mtge799 Mtge800

Mtge991

Mtge

992

Mtge

993

Mtge

994Mtge

996

Mtge

997

Mtge

998

Mtge

999

Mtge1000

Mtge

1191

Mtge

1192

Mtge

1193

Mtge

1194

Mtge1195

Mtge

1196

Mtge1199

Mtge

1200

Mtge1391

Mtge1392

Mtge1393

Mtge

1394

Mtge1395

Mtge1396

Mtge

1397

Mtge

1298

Mtge1399

Mtge1400

Mtge1591 Mtge1592 Mtge1593 Mtge1594 Mtge1595 Mtge1596 Mtge1597 Mtge1598 Mtge1599 Mtge1600


17/26

AAA

Tranche

AA

Tranche

A

Tranche

BBBTranche

Equity

Tranche

CDO

Structure

Special

Purpose

Vehicle

CDO

Trust

Note Coupon

(L + bps)

Proceeds

($)

Bond Coupons

(L + bps)

Proceeds

($)

Reference Portfolio

Collateral Pool

ABS

Tranche 15

ABS

Tranche 14

ABS

Tranche 13

ABS

Tranche 12

ABS

Tranche 11

ABS

Tranche 10

ABS

Tranche 9

ABS

Tranche 8

ABS

Tranche 7

ABS

Tranche 6

ABS

Tranche 5

ABS

Tranche 4

ABS

Tranche 3

ABS

Tranche 2

ABS

Tranche 1

ABS

Tranche 20

ABS

Tranche 19

ABS

Tranche 18

ABS

Tranche 17

ABS

Tranche 16

ABS

Tranche 25

ABS

Tranche 24

ABS

Tranche 23

ABS

Tranche 22

ABS

Tranche 21

ABS

Tranche 90

ABS

Tranche 89

ABS

Tranche 88

ABS

Tranche 87

ABS

Tranche 86

ABSCDO

Tranche 10

ABSCDO

Tranche 9

ABSCDO

Tranche 8

ABSCDO

Tranche 7

ABSCDO

Tranche 6


CDO Collateral Pool Can Include Tranches of Other CDOs

17

Tranches (bonds)

issued by other CDOs


18/26

Why Is It Difficult to Estimate the Value

of an ABS CDO?



19/26

Reference Portfolio

Collateral Pool

ABS

Tranche 15

ABS

Tranche 14

ABS

Tranche 13

ABS

Tranche 12

ABS

Tranche 11

ABS

Tranche 10

ABS

Tranche 9

ABS

Tranche 8

ABS

Tranche 7

ABS

Tranche 6

ABS

Tranche 5

ABS

Tranche 4

ABS

Tranche 3

ABS

Tranche 2

ABS

Tranche 1

ABS

Tranche 20

ABS

Tranche 19

ABS

Tranche 18

ABS

Tranche 17

ABS

Tranche 16

ABS

Tranche 25

ABS

Tranche 24

ABS

Tranche 23

ABS

Tranche 22

ABS

Tranche 21

ABS

Tranche 90

ABS

Tranche 89

ABS

Tranche 88

ABS

Tranche 87

ABS

Tranche 86

ABSCDO

Tranche 10

ABSCDO

Tranche 9

ABSCDO

Tranche 8

ABSCDO

Tranche 7

ABSCDO

Tranche 6


Why Is It Difficult to Estimate the Value of an ABS CDO?

19

(1) If the CDO collateral pool includes

say 90 ABS tranches, you need tomodel the probability distributions

of the cash flows of the 90 different

collateral pools. These collateral

pools can consist of many different

asset classes, e.g. subprimemortgages from different regions,

Alt-A mortgages, jumbo prime

mortgages, commercial mortgages,

credit card receivables, auto loans,

student loans, airplane leases, etc.(2) For most asset classes, limited

liquidity in underlying ABS makes

it difficult to calibrate the models to

market prices

There is a collateral

pool underlying each

ABS tranche


20/26

Reference Portfolio

Collateral Pool

ABS

Tranche 15

ABS

Tranche 14

ABS

Tranche 13

ABS

Tranche 12

ABS

Tranche 11

ABS

Tranche 10

ABS

Tranche 9

ABS

Tranche 8

ABS

Tranche 7

ABS

Tranche 6

ABS

Tranche 5

ABS

Tranche 4

ABS

Tranche 3

ABS

Tranche 2

ABS

Tranche 1

ABS

Tranche 20

ABS

Tranche 19

ABS

Tranche 18

ABS

Tranche 17

ABS

Tranche 16

ABS

Tranche 25

ABS

Tranche 24

ABS

Tranche 23

ABS

Tranche 22

ABS

Tranche 21

ABS

Tranche 90

ABS

Tranche 89

ABS

Tranche 88

ABS

Tranche 87

ABS

Tranche 86

ABSCDO

Tranche 10

ABSCDO

Tranche 9

ABSCDO

Tranche 8

ABSCDO

Tranche 7

ABSCDO

Tranche 6



20

(1) Also need to code the rules for

allocating the cash flows to thetranches issued by the 90

underlying securitizations. (These

are called the deal waterfalls.)

This is conceptually

straightforward, but the rules can becomplicated, and this step can be

time-consuming and burdensome.

(2) Plus you need to code the waterfall

of the CDO itself.

(3) In practice, often need to rely on a

vendor who has already done this,

e.g. Intex. But Intex does not cover

the entire universe of

securitizations.

Each underlying deal

has a waterfall that

must be coded


21/26

Reference Portfolio

Collateral Pool

ABS

Tranche 15

ABS

Tranche 14

ABS

Tranche 13

ABS

Tranche 12

ABS

Tranche 11

ABS

Tranche 10

ABS

Tranche 9

ABS

Tranche 8

ABS

Tranche 7

ABS

Tranche 6

ABS

Tranche 5

ABS

Tranche 4

ABS

Tranche 3

ABS

Tranche 2

ABS

Tranche 1

ABS

Tranche 20

ABS

Tranche 19

ABS

Tranche 18

ABS

Tranche 17

ABS

Tranche 16

ABS

Tranche 25

ABS

Tranche 24

ABS

Tranche 23

ABS

Tranche 22

ABS

Tranche 21

ABS

Tranche 90

ABS

Tranche 89

ABS

Tranche 88

ABS

Tranche 87

ABS

Tranche 86

ABSCDO

Tranche 10

ABSCDO

Tranche 9

ABSCDO

Tranche 8

ABSCDO

Tranche 7

ABSCDO

Tranche 6

ABSCDOTranche 5ABSCDOTranche 4ABSCDOTranche 3ABSCDOTranche 2

ABSCDO

Tranche 1


21

Tranches (bonds)

issued by other CDOs

The valuation problem can

become orders of magnitudemore complicated if the collateral

pool includes tranches of other

ABS CDOs


22/26

As an example, lets consider the cash-

flow model for a single asset class,

subprime mortgages



23/26

Approaches that have been used to value RMBS

Net Asset ValueValue based on current net liquidation value of assets.

Equity Tranche: Market value of reference assets (net of debt and otherliabilities) divided by notional amount of equity issued.

Debt tranches: Use debt coverage ratio as an indicator of risk

ComparablesFind priced security with similar characteristics to security

being valued (coupon, structure, rating, manager, )

Cash Flow Analysis

Model securitization and tranche of interest (collateral pool, waterfalls, and

triggers)

Create scenarios for default, recovery and prepayment to generate cash

flows from tranche over time

Discount cash flows to obtain present value of security

The cash flow approach can use fundamentalor market-impliedfuture default

rates, and can use deterministic or stochastic(Monte Carlo) scenarios

23 Neil D. Pearson


24/26

Components of a cash flow model

Neil D. Pearson

HPA model

Term structure

model

delinquency/default

/prepayment model cash flow

model valuation

model

Recovery

model

24

The delinquency/default/prepayment

model is the central component


25/26

Mortgage Transitions

Neil D. Pearson

pre-paid

current

30-days

60-days

90-days

default

pre-paid

current

30-days

60-days

90-days

default

pre-paid

current

30-days

60-days

90-days

default

pre-paid

current

30-days

60-days

90-days

default

If a loan transitions to become 60-days delinquent, in the next month it can

either prepay, return to being current, transition to 30-days delinquent,remain 60-days delinquent, or become 90-days delinquent. Need models of the

transition probabilities, or roll rates. For example, need a model of the

probability that a loan becomes 30-days delinquent given that it is

60-days delinquent, that is we need P(30-day | 60-day)

Month t+1 Month t+2Month t Month t+3

25


26/26

Model Components

Neil D. Pearson

Output of the HPA model consists

of scenarios of simulated future

house price appreciation rates,

passed to the delinquency

/default/prepayment and recovery

models

Output of the term structure model

consists of scenarios of simulated

future short and long-term interest

rates, which are passed to the

delinquency/default/prepayment and

cash flow models

HPA model

Term structure

model

delinquency/default

/prepayment model cash flow

model valuation

model

Recovery

model

Output of the delinquency/default

/prepayment model consists of

scenarios of monthly prepayments,

defaults, and delinquencies, which

are passed to the cash flow model

Output of the recovery model

consists of simulated recoveries

on foreclosed houses, which are

passed to the cash flow model

26

introduction toc dos

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