The Analysis of Structured Securities: Precise Risk Measurement and Capital Allocation

The Analysis of Structured Securities: Precise Risk Measurement and Capital Allocation

The Analysis of Structured Securities: Precise Risk Measurement and Capital Allocation

The Analysis of Structured Securities: Precise Risk Measurement and Capital Allocation

Synopsis

The Analysis of Structured Securities presents the first intellectually defensible framework for systematic assessment of the credit quality of structured securities. It begins with a detailed description and critique of methods used to rate asset-backed securities, collateralized debt obligations and asset-backed commercial paper. The book then proposes a single replacement paradigm capable of granular, dynamic results. It offers extensive guidance on using numerical methods in cash flow modeling, as well as a groundbreaking section on trigger optimization. Casework on applying the method to automobile ABS, CDOs-of-ABS and aircraft-lease securitizations is also presented. This book is essential reading for practitioners who seek higher precision, efficiency and control in managing their structured exposures.

Excerpt

Structured securities are debt securities backed by the pooled receivables of existing loans, leases, trade financings, bonds, or other financial assets whose credit risk generally has been delinked from the credit of the originator or seller by sale, swap, or assignment. the result is a transaction governed by a set of documents with covenants crafted to achieve a unique profile of risk and return for one or more tranches of debt. the classic motivations for a corporation to raise funds in the structured market rather than the corporate credit market are lower funding costs, better placement ability, balance sheet restructuring, and arbitrage of interest rates, credit spreads, taxes, or regulatory conditions.

Structured securities were first introduced to the market as a type of corporate bond. in its credit essence, however, a structured security is actually the opposite of a corporate bond: it is a tabula rasa unencumbered by business policy, market position, sectoral risk, management capability, agency conflict, or any other variable of performance save its target risk-adjusted return. It has no intrinsic character that cannot be effectively altered or eliminated by changing the asset mix, redirecting cash flows under outright or contingent payment instructions, or adding more capital.

The flexibility of structured securities confers upon them some efficiency advantages over their corporate counterparts. First, repackaging allows borrowers and their bankers to seek out the most liquid market sectors for placement. This creates better information linkages between the demand for and supply of credit, increasing the economic efficiency of the debt market. Structured securities also allow borrowers to raise funds more cheaply than by issuing corporate bonds. the gain is not solely due to financial “alchemy.” It has a sound credit basis. Ceteris paribus, if the procedures for creating cash securitizations are faithfully followed, investors have an investment in a pool of diversified assets of greater cash flow certainty than the credit of a single company; moreover, the structure of controls virtually eliminates discretionary uses of funds, increasing the certainty that cash collected will be used to pay investors. Also obvious, but frequently overlooked, is that the structuring process entails the disclosure of highly proprietary and potentially sensitive data. Historical asset-account-level data must be prepared in depth before origination and updated over the life of the structured transaction. Properly carried out, the due diligence process for a structured security yields a much richer data set than what is available from financial statement analysis. Moreover, the . . .

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