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SECURITIZED DEBT TRADING - MACQUARIE
David Méneret, Head of Securitized Debt Trading at Macquarie, MS FE ’02, Ecole Centrale Paris ‘ 02
November 2009
1. An introduction to securitization and its role in the credit crisis (2007-2009)
a) Securitization participants
b) From a house to a CDO, securitized products in between
c) Fannie Mae, AIG, Ambac, the banks and the rating agencies
2. How to trade securitized products?
a) ABS
b) CLO
c) MBS/CDO
d) Indices and correlated hedges
3. How to use what you learned in MSFE?
a) Monte Carlo Simulation
b) Stochastic Processes
c) Correlation Models
d) Volatility Models
Securitized Debt Trading
2
Broker
Securitization participants
Structuration/ Origination
Hedge Funds/ Prop Desks
Rating Agencies
Insurance Co/ Pension Funds
New ABS
Secondarymarket
Secondarymarket
Primary Market
Broker
ABS CDO/ SIV
Primary Market
Liquidation
Primary Market
Company XYZ
pledges assets
Sales and syndication
Monolines/ Liquidity Providers Hedges
Equity
3
1. An introduction to securitization and its role in the credit crisis (2007-2009)
a) Securitization participants
b) From a house to a CDO, securitized products in between
c) Fannie Mae, AIG, Ambac, the banks and the rating agencies
2. How to trade securitized products?
a) ABS
b) CLO
c) MBS/CDO
d) Indices and correlated hedges
3. How to use what you learned in MSFE?
a) Monte Carlo Simulation
b) Stochastic Processes
c) Correlation Models
d) Volatility Models
Securitized Debt Trading
4
Assets
Debt
Equity
Profit / Loss on A
sset
Priority of R
e-Paym
ent
Leverage Factor = Assets / Equity
A Basic Balance Sheet with Leverage
5
Return on Equity = 25%
[(Return on Assets - Interest Expense) / Equity] = 25%
[($9.00 - $4.00) / $20] = 25%
House
$100
Gain on House =
9%
Mortgage Debt
$80
Interest Rate =
5%
Equity
$20
Mortgage Gives Homeowners 5x’s Leveraged Returns
6
Pool of Mortgage Debts
Equity
D
D
D
D
D
D
D
D
D
D
D
Super Senior
AAA MBS
BB MBS
B MBS
BBB MBS
AA MBS
A MBS
Loss Position
Cre
ditR
isk
Yiel
d
FirstLoss
HighRisk
HighYield
LastLoss
LowRisk
LowYield
HOME
OWNERS
AAA MBS
Mortgage Securitization Creates “MBS” and Leverage
7
Pool of AA, A, BBB MBS
Equity
MBS
Super-Senior
AAA CDO
BB CDO
B CDO
BBB CDO
AA CDO
A CDO
Loss Position
Cre
dit R
isk
Yie
ld
FirstLoss
HighRisk
HighYield
LastLoss
LowRisk
LowYield
WALL
ST
BANKS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
AAA CDO
Pooling subordinated tranches to create ABS CDOs
8
Does not usually own reference asset
Going “long”
Benefits when reference asset price INCREASES
Tends to own reference asset
Hedging or going “short”
Benefits when reference asset price DECREASE
Protection SellerProtection Buyer
Payment upon Default of Reference Asset
Premium Payments
Reference Asset can be a MBS, CDO, Bond, or Loan
Like an insurance contract that pays in the event of default.
FASB requires mark-to-market valuation.
Collateral Call - Protection Buyers can call for partial payment if default event is likely.
Determined by mark-to-market value.
Credit Default Swaps
9
House
$100
Mortgage Debt
$95
Equity $5
Homeowner 20X’s
Increasing Leverage
Sub-prime Mortgage 20X’s Lev
10
House
$100
Mortgage Debt
$95
Equity $5
Mortgage Debt
$95
MBS
$91.8
Equity $3.2Homeowner 20X’s
Increasing Leverage
Mort. Securitiz 30X’s
Pooled into MBS – 30X’s Lev
11
House
$100
Mortgage Debt
$95
Equity $5
MBS
$91.8
CDO
$90.0
Equity $1.8
Mortgage Debt
$95
MBS
$91.8
Equity $3.2Homeowner 20X’s
Increasing Leverage
Mort. Securitiz 30X’s
CDO Structure 50X’s
Pooled into CDO – 50X’s Lev
12
CDS on CDO – Infinite Lev
House
$100
Mortgage Debt
$95
Equity $5
MBS
$91.8
CDO
$90.0
Equity $1.8
CDO
$90.0
CDS on CDO
$90.0
Equity $0
Mortgage Debt
$95
MBS
$91.8
Equity $3.2Homeowner 20X’s
Increasing Leverage
Mort. Securitiz 30X’s
CDO Structure 50X’s
Credit Default Swap ∞
13
Investment grade debt investors (BBB to AAA) do not expect to take a principal loss.
Super Senior was sold to Bank Conduits and SIVs that issued ABCP
The money market funds stopped buying ABCP and Banks had to back-stop.
Pool of Mortgage Debts
Equity
D
D
D
D
D
D
D
D
D
D
D
Super Senior
Aaa / AAA
Ba2 / BB
B2 / B
Baa2 / BBB
Aa2 / AA
A2 / A
HOME
OWNERS
Aaa / AAA
Money Market Fund
Bank Conduits/SIVs
Foreign Banks
Insurance Co.’s
CDO’s
Hedge Funds
Originating Banks
Dispatching the risk
14
For the first time in 70 years, housing prices went down after more than 15 years of exuberance.
Behavior of subprime borrowers was “rational” : many stopped paying their mortgages or even walked
away from houses they could not afford.
Rating agencies, monoline insurance companies, I-Banks, and investors did not anticipate this level of
default.Subprime Delinquencies
10
11
12
13
14
15
16
17
18
19
20
Mar
-98
Sep
-98
Mar
-99
Sep
-99
Mar
-00
Sep
-00
Mar
-01
Sep
-01
Mar
-02
Sep
-02
Mar
-03
Sep
-03
Mar
-04
Sep
-04
Mar
-05
Sep
-05
Mar
-06
Sep
-06
Mar
-07
Sep
-07
Mar
-08
% o
f Tot
al L
oans
Housing prices and delinquencies
15
Delinquent sub-prime homeowners are forced into foreclosure
Case Shiller Home Price Index - All Metro Areas
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
YOY
Perc
enta
ge C
hang
e
Foreclosures
16
The difference between overnight rates and 3 month rates sky-rockets to 3.50% (normally 0.15%). Fed Funds vs. LIBOR.
No borrowing / lending in the short term markets
This is precisely what Sect of Treasury was reacting to with bail-out
Counterparty risk / liquidity risk
17
0.0815
3.542
0.10838
0
0.5
1
1.5
2
2.5
3
3.5
4
Corporations could not borrow in the long term institutional bond markets
Hedge funds that bought bonds on leverage were forced to unwind
Investment Grade Yields
18
MBS/CDO Research: Case-Schiller Index (1/6)
Date Phoe
nix
- AZ
Los
Ang
eles
San
Die
go
San
Fran
cisc
o
Den
ver
Was
hing
ton
Mia
mi
Tam
pa -
FL
Atla
nta
- GA
Chi
cago
Bos
ton
Det
roit
- MI
Min
neap
olis
- M
N
Cha
rlott
e - N
C
Las
Vega
s
New
Yor
k
Cle
vela
nd -
OH
Port
land
- O
R
Dal
las
- TX
Seat
tle -
WA
Com
posi
te-2
0
September 1987 65.38 58 51 50 72 71 79 59 74 66 66 83 57 42October 1987 66.20 59 51 50 73 71 79 59 75 67 66 84 57 42November 1987 66.94 59 52 50 73 72 79 59 75 67 67 84 57 42December 1987 67.91 59 52 50 73 71 79 60 75 67 67 84 56 42January 1988 68.66 60 52 49 74 72 79 61 74 68 67 84 56 42February 1988 69.36 60 53 49 75 72 79 63 74 67 66 84 56 41March 1988 70.14 61 53 49 76 72 79 64 73 68 66 83 57 42April 1988 70.83 61 54 49 77 72 79 65 74 68 67 84 58 42May 1988 72.03 62 56 48 78 73 80 66 74 68 68 84 58 43June 1988 74.35 62 58 48 80 74 80 67 75 68 67 85 59 43July 1988 77.22 65 59 48 81 74 81 67 76 69 67 85 60 43August 1988 79.27 66 59 49 82 75 81 69 75 70 68 85 60 44September 1988 81.23 66 60 48 84 76 81 69 75 70 69 86 61 44September 1993 69 80 75 68 60 89 82 84 74 78 67 64 71 76 83 77 77 69 69September 1998 91 91 88 85 86 93 93 93 91 93 87 90 87 95 95 89 94 97 91September 1999 98 99 98 96 98 100 98 98 98 98 98 98 98 100 99 98 99 101 99September 2000 105 109 114 121 111 110 105 106 105 107 113 105 109 103 105 110 103 103 106 106 109September 2001 111 120 128 129 122 125 120 118 111 117 130 112 124 105 113 123 108 109 111 112 120September 2002 116 139 150 142 126 142 137 129 115 124 146 115 135 108 119 140 110 113 115 116 132September 2003 124 165 175 150 127 161 157 142 119 134 156 119 147 109 134 157 116 120 115 122 146September 2004 142 215 231 178 132 198 191 166 123 146 172 123 159 113 205 180 120 132 117 135 171September 2005 211 256 249 215 138 244 251 213 129 159 182 126 168 120 227 205 123 158 122 159 197September 2006 225 274 247 216 140 245 277 236 135 169 176 123 171 129 235 214 122 182 125 183 206September 2007 205 255 223 206 138 229 250 210 136 164 171 111 164 135 213 206 117 186 125 192 196September 2008 140 185 164 146 131 190 179 171 123 148 161 90 141 130 147 191 110 170 122 173 162October 2008 135 180 159 139 129 185 173 165 120 145 159 86 136 128 143 190 109 166 121 170 158November 2008 131 176 155 135 128 180 170 161 116 141 155 83 133 126 138 187 107 163 118 166 155December 2008 124 171 152 130 126 176 165 156 113 137 153 81 126 122 131 183 105 159 116 160 151January 2009 117 167 148 124 122 172 159 149 109 131 151 78 120 121 126 181 103 154 113 154 146February 2009 112 163 147 120 120 168 154 145 107 126 149 75 116 119 121 178 98 151 112 152 143March 2009 107 161 145 118 120 166 149 141 105 122 146 71 109 119 116 174 97 148 112 149 140April 2009 104 159 144 118 122 167 146 140 105 122 146 70 109 119 112 171 98 147 114 149 139May 2009 104 159 145 120 124 169 145 140 106 124 149 70 110 120 109 171 102 147 117 149 140June 2009 105 161 147 125 127 173 145 141 108 125 153 69 113 121 107 172 106 148 120 150 142July 2009 107 164 151 129 129 176 147 143 110 128 155 70 119 121 106 174 108 150 121 149 144August 2009 108 167 153 132 130 179 149 143 111 131 156 72 123 121 106 175 107 150 121 150 146Peak 227 274 250 218 140 251 281 238 136 169 182 127 171 136 235 216 123 187 126 192 207Last 12 months -14% -9% -6% -7% -1% -6% -13% -12% -5% -7% -3% -8% -7% -4% -17% -7% -1% -8% -1% -10% -7%YtD -13% -3% 1% 2% 3% 2% -10% -8% -2% -5% 2% -12% -3% -1% -19% -5% 2% -5% 5% -7% -3%Current Peak-to-Trough -54% -56% -49% -46% -14% -50% -57% -50% -23% -31% -29% -45% -37% -23% -55% -43% -22% -42% -12% -42% -42%
19
MBS/CDO Research: ABX trading (2/6)
20
MBS/CDO Research (3/6)
21
Source: Credit Suisse, Oct 27, 2009 [Severity first-lien]
MBS/CDO Research (4/6)
22
Source: Bloomberg Runs, Nov 16, 2009
MBS/CDO Research (5/6)
Source: JP Morgan, Chris Flanagan, Nov 13, 2009
Source: Citigroup, Rahul Parulekar, Nov 2008
Source: JP Morgan, Chris Flanagan, Nov 13, 2009
23
MBS/CDO Research (6/6)
24
Liquidity in Securitized products from 2006 to 2008
25
1. An introduction to securitization and its role in the credit crisis (2007-2009)
a) Securitization participants
b) From a house to a CDO, securitized products in between
c) Fannie Mae, AIG, Ambac, the banks and the rating agencies
2. How to trade securitized products?
a) ABS
b) CLO
c) MBS/CDO
d) Indices and correlated hedges
3. How to use what you learned in MSFE?
a) Monte Carlo Simulation
b) Stochastic Processes
c) Correlation Models
d) Volatility Models
Securitized Debt Trading
26
Pool of Mortgage Debts
Equity
D
D
D
D
D
D
D
D
D
D
D
Super Senior
Aaa / AAA
Ba2 / BB
B2 / B
Baa2 / BBB
Aa2 / AA
A2 / A
HOME
OWNERS
Aaa / AAA
FNMA
Guarantees Principal
and Interest Payments
FANNIE MAE (1/2)
27
Assets = $883bn
Equity = $44bn
Leverage = 20.1X’s
Guarantees = $2.9tn
Total Leverage = 85.7X’s
Write-downs in 2007
Inability to raise capital
Fed injects $100bn
Stock falls to near $0
CDS volatile as mkt not sure about Gov’t gty
FNMA’s Total Leverage is 85.7X’s
FNMA Stock and CDS
0
10
20
30
40
50
60
70
80
10/30/2006 3/13/2007 7/20/2007 11/27/2007 4/8/2008 8/14/2008
Stoc
k P
rice
0.00%
0.10%
0.20%
0.30%
0.40%
0.50%
0.60%
0.70%
0.80%
0.90%
1.00%
CDS
Annu
al P
rem
ium
Stock CDS
FNMA Balance Sheet Leverage
On B/S
Off B/S
$44,011$0
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
$3,000,000
$3,500,000
$4,000,000
Assets & Liabs Equiity
USD
in M
illio
nsFANNIE MAE (2/2)
28
Pool of AA, A, BBB MBS
Equity
MBS
Super-Senior
AAA CDO
BB CDO
B CDO
BBB CDO
AA CDO
A CDO
WALL
ST
BANKS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
AAA CDO
AIG Sells Protection Referenced to Super
Senior CDO
AIG (1/3)
29
AIGBanks
Holding Super Senior CDO
Protection SellerProtection Buyer
Payment upon Default of Reference Asset
Premium Payments
Reference Asset is Super Senior CDO
AIG gets premium of 0.15% on $527 billion or $790 mil per year
As mortgage losses mount and as investors stop buying MBS and CDO…
Mark-to-market of Super Senior CDO goes down
AIG is forced to post additional Collateral.
AIG (2/3)
30
Assets = $1.06tn
Equity = $95.8bn
Leverage = 11.1X’s
CDS on Super Senior = $527bn
Total Leverage = 16.6X’s
Write-downs of $12bn in 2007
MTM and Collateral Calls
Fed Loan of $85bn
Stock falls to near $0
CDS skyrockets to 25%
AIG Stock and CDS
0
10
20
30
40
50
60
70
80
10/30/2006 3/13/2007 7/20/2007 11/27/2007 4/8/2008 8/14/2008
Sto
ck P
rice
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
CDS
Annu
al P
rem
ium
Stock CDS
AIG Balance Sheet Leverage
On B/S
Off B/S
$95,801
$0
$200,000
$400,000
$600,000
$800,000
$1,000,000
$1,200,000
$1,400,000
$1,600,000
$1,800,000
Assets & Liabs Equiity
USD
in M
illio
nsAIG (3/3)
31
Pool of MBS
Equity
MBS
Ba2 / BB
B2 / B
Baa2 / BBB
Aa2 / AA
A2 / A
WALL
ST
BANKS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
MBS
Ambac
“Wraps”AA to Create AAA
Ambac (1/2)
32
Assets = $23.6bnEquity = $2.3bnLeverage = 10.4X’s
Wraps of CDO = $524bnTotal Leverage = 240X’s
Write-downs in 2007Downgrades and inability to do more business.Some MTM and Collateral CallsNY Insurance Commish InvolvedStock falls to near $0CDS skyrockets to 78.5 pts upfront
Ambac Balance Sheet Leverage
On B/S
Off B/S
$2,280$0
$100,000
$200,000
$300,000
$400,000
$500,000
$600,000
Assets & Liabs Equiity
US
D in
Mill
ions
Ambac Stock and CDS
0
20
40
60
80
100
120
10/30/2006 3/13/2007 7/20/2007 11/27/2007 4/8/2008 8/14/2008
Sto
ck P
rice
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
CDS
Ann
ual P
rem
ium
Stock CDS
Ambac (2/2)
33
Create risk positions without investing
Create risk positions that are “short” positions
Value goes up when prices go down
Like trading insurance contracts without the need to show evidence of an “insurable loss”.
Credit Default Swap Market
0
10,000
20,000
30,000
40,000
50,000
60,000
Dec 2004 June 2005 Dec 2005 June 2006 Dec 2006 June 2007 Dec 2007
USD
in B
illio
ns
Credit Default Swap Market
34
1. An introduction to securitization and its role in the credit crisis (2007-2009)
a) Securitization participants
b) From a house to a CDO, securitized products in between
c) Fannie Mae, AIG, Ambac, the banks and the rating agencies
2. How to trade securitized products?
a) ABS
b) CLO
c) MBS/CDO
d) Indices and correlated hedges
3. How to use what you learned in MSFE?
a) Monte Carlo Simulation
b) Stochastic Processes
c) Correlation Models
d) Volatility Models
Securitized Debt Trading
35
Aircraft ABS / CLO
AIRCRAFT ABS: Securitisation of 30 Aircraft Leases
Aircraft Lease #1Aircraft Lease #2Aircraft Lease #3 Senior………… Sub…Aircraft Lease #28Aircraft Lease #29 EquityAircraft Lease #30
CLO: Securitisation of 150 Leveraged Loans
Loan #1Loan #2Loan #3 Senior… AAA………… Jr AAALoan #148 AA & ALoan #149 BBB & BBLoan #150 Equity
Securitisation
fee
fee
Securitisation
36
RMBS/CMBS/CDO
RMBS/CMBS: Securitisation of 3000 Mortgages
Mortgage #1Mortgage #2Mortgage #3 1st AAA……… 2nd AAA… Pen AAA… Last AAAMortgage #2998 AA & AMortgage #2999 BBB & BBMortgage #3000 Equity
CDO of ABS: Securitisation of 80 Asset-Backed Securities
ABS #1: RMBSABS #2: RMBSABS #3: RMBS Senior … AAA……… Jr AAA… AAABS #78: CLO AABS #79: CMBS BBBABS #80: Aircraft ABS Equity
Securitisation
fee
Securitisation
fee
37
ABS
Asset-Backed Securities:• Aircraft ABS: secured by aircraft lease rates or by actual planes• Auto ABS: secured by auto loans• Credit Card ABS: secured by credit card loans• Container ABS• Railcar ABS• Esoteric ABS (wrapped and unwrapped): film rights, tobacco settlements, insurance fees
Indices and correlated hedges• HY Index• CDS on Leasing Companies/Airlines• CDS on Monolines
38
CLO
Collateralized Loan Obligations:• CLO Tranches: AAA, jr AAA, AA, A, BBB, Equity• Cash, CDS on CLO
Indices and correlated hedges• LCDX• LCDX Tranches• CDS on CLO
39
MBS/CDO
RMBS/CMBS, Subprime and Home Equity:• Current pay RMBS• Second pay RMBS• Third pay RMBS• Credit IOs (remote likelihood of paying principal)
Collateralized Debt Obligations:• Senior Tranches • Trading various tranches of CDOs issued between 2000 and early 2005• Running an ABX-calibrated fundamental model to price underlying RMBS/CMBS bonds
Indices and correlated hedges• ABX• TABX• CDS on RMBS• CDS on ABS CDO• CMBX
40
1. An introduction to securitization and its role in the credit crisis (2007-2009)
a) Securitization participants
b) From a house to a CDO, securitized products in between
c) Fannie Mae, AIG, Ambac, the banks and the rating agencies
2. How to trade securitized products?
a) ABS
b) CLO
c) MBS/CDO
d) Indices and correlated hedges
3. How to use what you learned in MSFE?
a) Monte Carlo Simulation
b) Stochastic Processes
c) Correlation Models
d) Volatility Models
Securitized Debt Trading
41
Monte Carlo Simulation
Step One: INPUT• CPR, CDR, Leases, Default Probability, Correlation, Remarketing/Repossession costs• Calibration of Input to Market data: ABX, interest rates, HPA, implied correlation
Step Two: SCENARIO GENERATION• 1000 to 100000 portfolio cash flow scenarios are generated by applying a default
probability to underlying loans/leases and calculating remaining cash flows based on the probability distribution and correlation of the input factors
• Tools: Matlab, VBA/VB.net, Intex• N x M matrix of cash flows (N scenarios, M months)
Step Three: EXPECTED VALUE AND DISTRIBUTION• Portfolio Cash Flows: expected cash flows and their distribution on a monthly basis• Present value of Portfolio Cash Flows (discount rate = marginal cost of funding)• Portfolio market Value: distribution on a monthly basis (= recovery value of portfolio)
Step Four: RISK/REWARD PROFILE• Distribution of expected loss vs bond yield before hedges• Distribution of expected loss vs bond yield after hedges (assuming various correlation
assumptions)
42
Stochastic Processes
RMBS/CMBS/CLO:• Main variables: prepayment rate (CPR), default rate (CDR), severity (loss given default)• d (Log X (t+1)) = K x ( m(t) – Log X (t) ) dt + σ d W(t)• d (Log X (t+1)) = K x ( m(t) – Log X (t) ) dt + σ (t) d W(t)• Correlation between CPR, CDR, severity.• Hull-White, Ho-Lee, HJM
Aircraft ABS, Railcar ABS, Container ABS:• Very high correlation • Modeling future lease rates• Modeling defaults of lessees• Modeling remarketing/repossession costs
43
Correlation Models
Gaussian Copula Model
• Li's paper "On Default Correlation: A Copula Function Approach" (2000)
• The Gaussian Copula model quickly became a tool for financial institutions: correlation desks, CDO structuring, bespoke, etc.
• According to Nassim Nicholas Taleb, "People got very excited about the Gaussian copula because of its mathematical elegance, but the thing never worked. Co-association between securities is not measurable using correlation“
…How to use a proper correlation model? • Run wide range of sensitivities to assumptions• Know limits of the model
44
Volatility Models
Black-Scholes Model:• Distressed Debt tends to behave like equity: large swings and sensitivities to many
macroeconomic factors, uncertain payments, timing of default, recovery value• Some bonds may trade above 50% even though their recovery value is 10% and the
cumulative probability of default is 90% (IO Value)• Some bonds may trade below their recovery value (cost of funding)
Limits of the model:• Limited upside (par)• Not exactly like Equity
Stress tests and volatility around the median (example: Aircraft ABS)Modelling future cash flows based on current lease rates:Stress Cases Good Quality Aircraft Medium Quality Aircraft Bad Quality Aircraft
Bear Case Lease rates cut immediately to 80%, then 50% then 30%.
Lease rates cut immediately to 80%, then 30% then 0%.
Lease rates cut immediately to 60%, then 0%.
Base Case Lease rates cut immediately to 90% then 70% then 50%.
Lease rates cut immediately to 90% then 50 % then 30%.
Lease rates cut immediately to 80% then 30% then 0%.
Bull Case Lease rates kept as is, then cut to 90% then 70%.
Lease rates kept as is, then cut to 70% then 50%.
Lease rates kept as is, then cut to 50% then 30%.
45
HPA-Based Models for RMBS and ABX
Loan-Based Cash Flow Model calibrated with ABX (indicative levels)
ABX AAA 07-2 Prices in 25 different scenarios
CDR CDR CDR CDR CDR15 22.5 45 60 75
CPR 0 50.75 44.55 36.03 32.66 29.93CPR 2.5 57.42 46.28 37.19 33.68 30.70CPR 5 63.74 48.08 38.55 34.60 31.47CPR 15 78.25 69.06 43.12 38.32 34.32CPR 20 82.15 77.70 45.49 40.15 35.76
ABX-Implied Peak-to-Trough Housing Price Depreciation
CDR CDR CDR CDR CDR15 22.5 45 60 75
CPR 0 -49.00 -51.70 -59.80 -65.20 -70.60CPR 2.5 -40.50 -43.65 -53.10 -59.40 -65.70CPR 5 -32.00 -35.60 -46.40 -53.60 -60.80CPR 15 -23.50 -27.55 -39.70 -47.80 -55.90CPR 20 -15.00 -19.50 -33.00 -42.00 -51.00
ABX 07-2 AAA
-$$10$20$30$40$50$60$70$80$90
-80 -60 -40 -20 0HPA (Peak-to-trough)
Price
46
Decision Process for CLO and RMBS trading
Experts Meneret Meneret Meneret Meneret MeneretRMBS Trader RMBS Trader Head of Trading RMBS trader Credit Trading Team
Loan-by-Loan Structural Loan Servicer Valuation Decision NOPortfolio Analysis Analysis Review Process Process
TRADESensitivity Housing Prices (HPA) Triggers Loan Modifications Credit Risk: CDR Counterparty RiskAnalysis (Case-Shiller Index) Enhancement Foreclosures ABX Microeconomic factors
Commercial Real Estate Event of Default Collections CMBX Macroeconomic factors(CPPI, external research) Liquidation Volatility Inflation/DeflationFuture Values of Assets Acceleration Correlation Capital MarketsHome-by-Home Prepayment Risk: CPR Bailout RiskState-by-State Loss Severity Liquidity RiskMSA-by-MSA Rating Agency Action Technical PressuresLoan Type Interest RatesMortgage Type Currency Risk
SELL
BUY
Process
Experts HY Trader Meneret Head of Trading Meneret MeneretCLO Trader CLO Trader Meneret CLO Trader Credit Trading team
Loan-by-Loan Structural Portfolio Manager Valuation Decision NOPortfolio Analysis Analysis Review Process Process
TRADESensitivity Outlook per industry Triggers Manager Risk Credit Risk: CDR Counterparty RiskAnalysis Outlook per company Enhancement Reinvestment Risk LCDX Microeconomic factors
Loan Market Prices Event of Default LCDX Tranches Macroeconomic factorsLoan Fundamental Prices Liquidation Volatility Inflation/DeflationRecovery per company Acceleration Correlation Capital Markets
Prepayment Risk: CPR Bailout RiskRecovery Risk Liquidity RiskRating Agency Action Technical PressuresInterest RatesCurrency Risk
Process
BUY
SELL
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But also:
Risk Management:• Managing a trading book requires precise understanding and monitoring of credit risk and
market risk• Liquidity risk• Interest rate risk• Basis risk• Currency risk• Greeks: delta/gamma/vega/theta/rho• Carry: positive/negative• Servicer• Government intervention
Legal Analysis (indenture/prospectus/reports)• Event of default/liquidation• Priority of payments• Running an ABX-calibrated fundamental model to price underlying RMBS/CMBS bonds
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SECURITIZED DEBT TRADING - MACQUARIE
David Méneret, Head of Securitized Debt Trading at Macquarie, MS FE ’02, Ecole Centrale Paris ‘ 02
November 2009
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