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Subprime mortgage bonds and ABS CDOs have become the biggestcredit and risk management failure in history. Their story is oneof how a small, inconsequential part of the mortgage market grewinto a monster large enough to shake the very foundations of theU.S. financial system. It is a story with some elements that areold and some that are new, and it is a story that is far from over.In the meantime, analysts and investors are left wondering abouthow the $700 billion of outstanding subprime securities should bevalued.
Written by an expert team of practitioners from UBS—theworld's largest wealth manager and a top tier investment bankingand securities firm—and Frank Fabozzi of Yale University,Subprime Mortgage Credit Derivatives offers readers the beststrategies and risk management tools for dealing with today'sgrowing and currently volatile subprime mortgage credit derivativesmarket. The authors examine the factors that determine default andprepayment risk, and in the process outline the origins of thecurrent subprime crisis. They look at how the three forms ofsubprime mortgage risk—cash, single name ABCDS, and theABX—differ and what drives their relative spreads. And theyexamine the salient features of the excessspread/overcollateralization structure used on most subprimesecurities since 1998, showing how even a small change in theprepayment rate or default rate can cause a major shift in cashflows, which in turn can have a major impact on valuations.
Explaining how an understanding of ISDA CDO CDS documentation iscritical, the authors dissect this document into its working partsand explain each—sorting out the five credit problems thedocumentation recognizes can happen to a CDO and the twoconsequences for which the documentation provides. They alsoprovide a simple model that will prove useful in predicting whichlower quality bonds will write down and when the write-downs willhappen.
For all those who want to go long or short thesederivatives—as well as understand more about the marketpricing of cash underlyings—Subprime Mortgage CreditDerivatives will prove to be an invaluable resource.
About The Authors.
Part One. Mortgage Credit.
Chapter 1. Overview of The Nonagency Mortgage Market.
Roots Of The 2007–2008 Subprime Crisis.
Defining Characteristics Of Nonagency Mortgages.
Agency versus Nonagency Execution.
Chapter 2. First Lien Mortgage Credit.
Concepts and Measurements of Mortgage Credit.
Collateral Characteristics and Mortgage Credit: Assault of theFour Cs in 2006 (Credit, Collateral, Capacity And Character).
The End Game: Foreclosure, REO Timeline, and Severity.
The Role of Unobservable in 2006 Subprime Mortgage Credit.
Chapter 3. Second Lien Mortgage Credit.
Two Types of Seconds.
Higher Risks in Seconds.
Why Higher Losses?
Part Two. Mortgage Securitizations.
Chapter 4. Features of Excess Spread/Overcollateralization:The Principle Subprime Structure.
Excess Spread-Based Credit Enhancement.
OC In Alt-A-Land.
OC Internal Workings.
Chapter 5. Subprime Triggers and Step-Downs.
The Step-Down and the Trigger.
BBB Stack (on The Knife's Edge).
Effect of Triggers and the Loss Waterline.
Sampling the Subprime Universe.
2000–2003 Deal Step-Down Summary.
Step-Down and Credit Effects.
Part Three. Credit Default Swaps On MortgageSecurities.
Chapter 6. Introduction To Credit Default Swap On ABSCDS.
Corporate CDS Fundamentals and Terminology.
Differences Between Corporate CDS and ABS CDS.
Difficulties in ABS CDS.
ABS CDS Effect on ABS CDO Management.
Two New Types of ABS CDOs.
Chapter 7. The ABX and TABX Indices.
How a Deal Gets into the Index.
Index Pricing Over Time.
ABX Tranche Trading.
TABX versus CDOs.
Chapter 8. Relationship among Cash, ABCDS, and theABX.
Fundamental Contractual Differences-Single Name ABCDS/ABXIndex/Cash.
What Keeps The Arbitrage From Going Away?
Appendix: Importance of ABCDS to CDO Managers.
Chapter 9. Credit Default Swaps on CDOs
CDO CDS Nomenclature.
CDO Credit Problems and their Consequences.
Alternative Interest Cap Options.
Cash CDO versus CDO CDS.
Exiting a CDO CDS.
Rating Agency Concerns on CDOs that Sell Protection via CDOCDS.
Part Four. Loss Projection and Security Valuation.
Chapter 10. Loss Projection for Subprime, Alt-A, and SecondLien Mortgages.
Two Ways Of Projecting Loss.
Steps In Predicting Collateral Losses.
Pros and Cons of the Default Timing Curve.
Historical Model Fit versus Actual.
Default Timing Is Not Equal To Loss Timing.
An Alternative Specification.
Alt-A And Closed-End Seconds.
Chapter 11. Valuing the ABX.
Review of Basic Valuation for ABX Indices.
Review of Valuation Approaches.
The “Simple” or Do-It-Yourself Approach To ABXValuation.
ABX After Subprime Shutdown.
Appendix: Results of Original “Base” Pricing (AndNumber of Bonds Written Down) and the New “Shutdown”Estimates.
Chapter 12. ABS CDO Losses And Valuation.
The Mortgage Loan-Mortgage Bond-ABS CDO Chain.
Mortgage Deal Losses.
Subprime Mortgage Bond Losses.
Alt-A, Second Lien, And Prime Mortgage Bond Losses.
Aggregating Mortgage Bond Losses In 2006–7 Mezzanine ABSCDOs.
Aggregating Mortgage Bond Losses In 2005 Mezzanine ABS CDOs.
Drivers of CDO Losses And The Role Of The Manager.
ABS CDO Valuation And CDO Structure.
Section Five. Subprime Meltdown.
Chapter 13. The Great Subprime Meltdown Of 2007.
An Earlier Subprime Crisis.
The Virtuous Cycle.
Early-Pay Defaults: The First Hint Things Were Changing.
The 2006 Conundrum.
Banking Regulators: Not Too Little But Too Late.
Who Will Rescue the Subprime Borrower?
Is Securitization The Villain?
Lack of Transparency.
Future for Subprime.