7/24/2019 DB Jim Grant Email to HFs
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From:
GREG
LIPPMANN
(DEUTSCHE
BANK
SECURI)
Sent:
Tuesday,
August 29,
2006
2:12
PM
To:
PAOLO.PELLEGRINI
;
NLOBACCARO
;'EKOSNIK
;
MARC
;
RICHARD
BARRERA
(GLENVIEW
CAPITAL
MAN)
;
PAOLO
PELLEGRINI
(PAULSON
&
CO.
INC.)
;
DAVID
MACKNIGHT
(MASON
CAPITAL
MANAGE)
;
ALAN
FOURNIER
(PENNANT
CAPITAL)
;
MICHAEL
PENDY
(DUQUESNE
CAPITAL
MAN)
;
NICK
LOBACCARO
(GEORGE
WEISS
ASSOCIA)
;
EDWARD
KOSNIK
(HUNTER
GLOBAL
INVEST)
;
JEREMY
COON
(PASSPORT
MANAGEMENT,)
;
JAMES
DIDDEN
(GSO
CAPITAL
PARTNERS)
;
GREGORY
PAPPAJOHN
(VARA
CAPITAL
LLC)
;
BRADLEY
WICKENS
(SPINNAKER
CAPITAL
LT )
;
MICHELLE
BORRE
(OPPENHEIMERFUNDS,
IN)
;
CEMIL
URGANCI
(ASHMORE
GROUP
LIMITE)
;
PAUL
TWITCHELL
(WHITEBOX
ADVISORS,
L)
;
SHAILESH
VASUNDHRA
(DEEPHAVEN
CAPITAL
MA)
; ANTHONY
BOZZA
(SAB
CAPITAL MANAGEME)
;
BRAD
ROSENBERG
(PAULSON
&CO.
INC.)
;
TYLER
DUNCAN
(WAYZATA
INVESTMENT
P)
;
STEVE
ROTH
(GLG
PARTNERS
LP)
;
DAVID
GERSZEWSKI
(AUTONOMY
CAPITAL
RES)
;
LEV
MIKHEEV
(MOORE
EUROPE
CAPITAL)
;
STEFAN
TSONEV
(UBS
LIMITED)
;
WYATT
WACHTEL
(YORK
CAPITAL
MANAGEM)
;
RENE
HO (MORGAN
(J.P.))
;
JOHN
GISBORNE
(TORONTO
DOMINION
BAN)
;
MATTHEW
J KEEGAN
(OSPRAIE
M ANAGEMENT
L) ;
PHILIP
GUTFLEISH
(ELM
RIDGE
VALUE
ADVI)
;
JEFF
MOSKOWITZ (MORGAN
STANLEY)
;
KENNETH
COE
(TALEK
INVESTMENTS
LL) ,
MATTHEW
BASS
(GSO
CAPITAL
PARTNERS)
;
ROPER
STRYPE
(RUBICON
FUND
MANAGEM)
,
ROBERT
NEMETH
(ELM RIDGE
VALUE
ADVI)
;
MARC
LEHMANN
(JANA
PARTNERS
LLC.)
;
JEREMY
SCHIFFMAN
(TPG-AXON
CAPITAL
MAN)
;
JORIS
HOEDEMAEKERS
(OASIS
CAPITAL
(UK)
L)
;
NEL JOSHI
(DEEPHAVEN
CAPITAL
MA)
;
DANIEL
DONOVAN
(GDG)
;
RAGHU
RAGHAVENDRA
(MOORE
EUROPE
CAPITAL)
;
CHAD
KLINGHOFFER
(GLENVIEW
CAPITAL
MAN)
;
JOSH ADAM
(GLG INC.)
;
JEREMY
SIMON (TPG-AXON
CAPITAL
MAN)
;
BRIAN VAHEY
(KING
STREET
CAPITAL)
;
DEAN
CARLSON
(SUSQUEHANNA
INVESTME)
;
JEAN
FAU
(DARBY
CAPITAL
IRELAN)
;
VARUN
GOSAIN
(CONSTELLATION
CAPITA)
;
MAULIN
SHAH
(POLYGON
INVESTMENT
P)
;
HARRY
MAMAYSKY
(OLD LANE,
LP)
Subject:
Fwd:
Two
Jim
Grant
articles
on
CDOs
Attach:
15664357.htm
Permanent
Subcommittee
on
Investigations
Wall
Street
The
inancial
Crisis
ential
Treatment
Requested
by
DBSI
Report
Footnote
#963DBSI_PS_EMAIL0
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onfi
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Message Sent:
08/29/2006 09:12:02
From:
GREGLIP@BBOTGIGREG
LIPPMANNIDEUTSCHE
BANK
SECURIl]7261328663
To:
I
To:
II
To:
I
To:
MARC@JANAPARTNERS COMMARC|I
I
To:
RBARRERA2@BBOTGIRICHARD
BARRERAIGLEN
VIEW
CAPITAL
MANI I
To:
PPELLEGRINI3@BBOTGIPAOLO
PELLEGRINIIPAULSON
&CO.
INC.| I
To:
DMACKNIGHT@BBOTGIDAVID
MACKNIGHTIMASON
CAPITAL MANAGE
I
To:
AFOURNIER@BBOTGIALAN
FOURNIERIPENNANT
CAPITAL
I
To: GMPENDY@BBOTG MICHAEL
PENDYIDUQUESNE
CAPITAL
MAN|
I
To:
NLOBA@BBOTGINICK
LOBACCAROIGEORGE
WEISS ASSOCIAI
To:
EKOSNTK@BBOTGIEDWARD
KOSNIKIHUNTER
GLOBAL
INVEST|
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To:
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COONIPASSPORT
MANAGEMENT,|
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To:
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DIDDENIGSO
CAPITAL PARTNERSI
I
To:
GPAPPAJOHN4@BBOTGIGREGORY
PAPPAJOHNIVARA
CAPITAL
LLCI
I
To:
BWICKENSI@BBOTGIBRADLEY
WICKENSISPINNAKER
CAPITAL
LTI I
To:
MBORRE
I@BBOTG|MICHELLE
BORRE|OPPENHEIMERFUNDS,
N|
I
To:
CURGANCII@BBOTGICEML
URGANCIIASHMORE
GROUP
LIMITE
I
To: PTWITCH@)BBOTGIPAUL
TWITCHELL WHITEBOX
ADVISORS,
LI I
To: SVASUND@BBOTGISHAILESH
VASUNDHRAIDEEPHAVEN
CAPITAL MAI
I
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ABOZZA@BBOTGIANTHONY
BOZZAISAB
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MANAGEMEI
I
To:
BSROSENBERG@BBOTG BRAD
ROSENBERG
PAUL
SON
&
CO.
INC.1
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To: TJDUNCAN@BBOTGITYLER
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YZATA
INVESTMENT
PI
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ROTHIGLG
PARTNERS
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TONOMY
CAPITAL
RES|
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MIKHEEVIMOORE
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CAPITALI
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To: TSONEVS@BBOTGISTEFAN
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LIMITED|
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To:
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WACHTEL|YORK
CAPITAL
MANAGEMII
To:
RENEHO@BBOTG|RENE
HOIMORGAN
(JP.)
To:
JGISBORNE@BBOTG|JOHN
GISBORNEITORONTO
DOMINION
BAN
To:
MAKEEGAN@BBOTG|MATTHEW
J KEEGANIOSPRAIE
MANAGEMENT
LI
I
To:
PGUTFLEISH2@BBOTG|PHILIP
GUTFLEISHIELM
RIDGE
VALUE
ADVII
I
To: JMOSK@BBOTGlJEFF
MOSKOWITZIMORGAN.STANLEY
To:
KCOE1@BBOTGIKENNETH
COEITALEK
INVESTMENTS
LLI
I
To: MBASSI@BBOTGIMATTHEW
BASSIGSO
CAPITAL
PARTNERS
I
To: RSTRYPEI@BBOTG|ROPER
STRYPEIRUBICON
FUND
MANAGEMI
I
To:
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VALUE
ADVII
I
To:
MARCLEHMANN@BBOTGIMARC
LEHMANNIJANA
PARTNERS
T.IC.1I
To:
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SCHIFFMANITPG-AXON
CAPITAL MAN
To:
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HOEDEMAEKERSIOASIS
CAPITAL
(UK)
LI
To: NJOSHI@BBOTGINEIL
JOSHIIDEEPHAVEN
CAPITAL
MA
To: DDONOVAN5@BBOTGDANIEL
DONOVANIGDGI
To:
RAGHAVENDRA@BBOTGIRAGHU
RAGHAVENDRAIMOORE
EUROPE
CAPITALI
To: CKLINGH1IOFFER@BBOTGICHAD
KLINGHOFFERIGLENVIEW
CAPITAL
MAN
To: JOSHADAM@BBOTG|JOSH
ADAMIGLG
INC.
I
To:
JSIMONTPG@BBOTGIJEREMY
SIMONITPG-AXON
CAPITAL
MAN
To:
BVAHEY@BBOTGIBRIAN
VAHEYIKING
STREET
CAPITAL
To:
DCARL@BBOTGIDEAN
CARLSONISUSQUEI
HANNA
INVESTME|
|
To:
JFAU@BBOTGJEAN
FAU|DARBY
CAPITAL
IRELAN|
|
To: VGOSAINI@BBOTGIVARUN
GOSAINICONSTELLATION
CAPITA
To: MAULIN
SHAH@BBOTGIMAULIN
SHAH|POLYGON
INVESTMENT
P| I
To:
H.MAMAYSKY@BBOTG|HARRY
MAMAYSKY|OLD
LANE.
LP
Original Message-
From:
Greg
Lippmann
At:
8/28
17:32:17
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Structured Complacency
Credit markets
are
sanguine.
Structured
credit
is
proliferating.
Could
the
first fact
be related
to
the
second?
Yes,
we say.
There?s
no end
of explanation
for the
mysterious
willingness
of
bond
buyers and
bank-loan
investors
to accept
persistently
modest
returns
over
riskless
government
yields.
Liquidity
has
been
superabundant,
hedge-fund
assets are on
the
prowl, yield
thirst goes
unslaked?all
these causes
are put
forward.
We
are
about to
suggest
another
explanation
for the
bewildering
complacency
of
lenders.
Spreads
are
tight
in
part because
of
the
growing number
of
collateralized
debt
obligations
(CDOs).
What
these entities
share is
a strong
propensity
to
buy and
a
low
propensity
to sell.
A
new fact
commands
the attention of
lenders
and
borrowers:
Financial
engineering
is displacing
credit
analysis.
Definitions
are in order.
A
CDO
is
a debt-acquisition
enterprise.
It
raises money from
investors.
It
acquires assets with
the proceeds?bonds,
bank
loans,
mortgages,
asset-backed
securitics,
etc.
It can buy
floating-rate assets
or
fixed-,
senior
claims
or subordinated.
In 2005,
no
less
than
$250
billion
of
CDOs came into the
world, 59%
more than
in
analysis,
we
venture
the following
capsule
distinction:
financial
engineering
is the
science
of structuring
cash
flows; credit
analysis
is
the
art
of getting paid.
The
liabilities
side of
a CDO
balance
sheet
is what
gives
the
structure
its
distinctive
investment
personality.
The
liabilities
are
layered.
Field-strip
a
typical
$100
million
CDO and
you find,
first,
a
large
swath
of
?senior?
liabilities,
say
$70 million
worth,
rated
triple-A;
a $20
million
?junior?
slice
rated
single-
or
double-A;
a 3
million
mezzanine
piece
rated
triple-B;
and
7 million
of
unrated
equity.
The top-rated
assets
are
not
inherently
triple-A.
Their
strength
derives
rather
from the
vulnerability
of
the
assets
underneath.
The
equity
tranche
is
most
exposed; to it
goes
the
first
loss. When
it
has borne
all
it
can bear
(i.e.,
7 million),
the
next
loss goes to
the
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mezzanine tranche and the
next to the junior
slice.
Only
after all of
these levees are
breached--$30
million
worthdo
losses cut
into the value
of the senior segment.
The
various segments are
priced according
to their risk,
with
the senior-most
yielding
a
few
dozen
basis
points
over
Libor and
the
equity
segment returning
1,000
basis points
over (or
more). The
cost
to
create
such a structure
runs to about 1.5%
of
the
balance-sheet
footings.
Included
are legal,
rating and
origination expenses.
Annual
management
fees may
run to 50
basis points.
Although
some
CDOs are
?static??the
assets with
which they
are seeded
are the
ones
they
keep?some
latitude
for
the managers is
increasingly the
norm.
Our
?typical? CDO
is known
as a ?cash?
CDO It
is not to he
confused
with a ?synthetic? CDO.
Like the
cash variety,
a synthetic
CDO
raises
money from
investors. Then
it sells
credit protection
to
other
investors,
in the shape
of credit
default
swaps
(CDS). The
cash CDO
eams
income from
the securities
it holds.
The synthetic
CDO
eairns income-from
the premium
it writes.
In
a
few
short years,
these
derivative structures
have
marginalized
the
vast corporate
bond market.
Companies
still
issue public
debt, but
Wall Street
is
trading less
and less
of
it. The charm
of
the
old corporate
arena?with its
generously
separated bids
and
offers and
its
personable,
richly
compensated
sales
peopleproved its
undoing. Th e
advent of
price
transparency
through the
TRACE
reporting system
hathed the
marketplace
in sunlight.
Blinking,
the
salespeople
watched
quotations
tighten and
commission
income dwindle.
?Banks
that trade
corporate
bonds
have been
required
to report
transactions
to TRACE
since
2002,?
Bloomberg
noted
in a May
9
report
on
the historic
shift
from
cash transactions
to derivative
ones
(?Derivatives
Make
Nich Carraway,
Corporate
Bond
Traders Obsolete,?
is
the
headline).
?The
system now provides
prices and the
amount
of
bonds
exchanged
in
each
trade on
29,000
securities with
in 15 minutes
of a deal,
according
to
NASD.
With
the data
available,
there?s
little
need
for guidance
from
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analysts
or
salespeople.?
Observe,
please, the
analytical
leap
implied in
the
final
three
words
of
the
quotation: ?analvsts
or salespeople.?
Why should
price
transparency
make
analysts obsolete?
Hypothesis
No.
1:
Because, in an
efficient
market,
a security?s
price
is
the unfailing
measure of
its
value.
Hypothesis No. 2: Because,
on
Wall Street, the
analysts are
paid
out
of the
big fat commission
pot.
We
lean
toward No.
2.
Credit risk is
ever present.
Where it
resides is
the timely
question.
Once
upon a
time, before
?disintermediation,?
the
risk
of
default
or nonpayment
lay with
the
banks.
It was the
banks? business
to
know more
about
their borrowers
than
anyone else.
Come the
junk-bond
revolution, the
risk
migrated out
of
the
banks and into the
securities
markets. Now
comes
the
derivatives
boom.
Who
are
the keepers
of
the
flame
of
credit analysis in
2006?
We?re
not sure?and
neither is
the International
Monetary
Fund.
?[R]ating agencies
have
played
a significant
role in
the
acceptance of
new
products
by investors,
with the analysis
and rating
of structured
products
heavily reliant
on
sophisticated
quantitative
modeling,? says
IMF?s
2006 Global
Financial
Stability
Report (see
Chapter
2, ?The
Influence
of
Credit
Derivative
and
Structured
Credit
Markets on
Financial
Stability?).
?Not
surprisingly.
The
development
of
structured
credit
markets
has coincided
with
the increasing
involvement
of people
with
advanced
financial
engineering
skills required
to
measure and
manage these
often
complex risks. In
fact,
for
many
market
participants,
the
application of such
skills may
have become
more
important than
fundamental
credit
analysis.?
This provocative
thought is
developed
in a one-sentence
footnote, as
follows: ?Discussions
with
market participants
raised
questions as to
whether the
increased
focus on
?structuring?
skills,
relative
to
?credit?
analysis,
may itself
present
a
concern.?
Emphatically,
the
rating agencies
are on
the
job. Since
a CD O
without a triple-A-rated
senior
tranche
would
be
unmarketablc,
their
imprimatur is
indispensable.
For
Moody?s Corp.,
the
sole publicly
traded
rating business,
derivatives
are the
wave
of
the
futurc?and
of the
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present,
besides. In the
first
quarter,
structured finance
generated
revenues
of $176
million,
nearly
double the contribution
of
oldOline
corporate debt
ratings.
Colleague Ian
McCulley
was
unable to
elicit from any
agency
just
what this
booming
business
entails.
But
he did catch
up
with ajunior
analyst
at one
ratings
shop,
who
described
his work
in monitoring
as
many
as
20
CDOs
a day. Both
the analyst?s
name and his
employer?s
are being
withheld
to
protect
the innocent.)
?Basically,?
says our
source,
?I
go
through
what they
buy and
sell
each
month.
And
I
go
through
all of their
ratios.
And
I check
to
see if
they
have synthetics,?
e.g.,
credit
default
swaps.
It?s all in
an Excel
model.
The
CDOs he checks
are actively
managed.
Interestingly,
some of
them
invest in
the
tranches
of other
CDOs, and
they
are
called
?CDO squared.?
It?s
no easy
matter
to rate
these
exotica,
even
with
the
help of
a complex
model
developed
for the
purpose
by
Moodys.
Our
admittedly green
contact
says
he
doubts that
many
people
really
understand
what these
structures
own, how
their
assets
are
correlated
or
what might
happen
to
them
in
the
liquidation
portion
of
a
credit
cycle.
A skeptical
friend of
ours
applauds
the bank-loan-holding
CDOs. Michael Lewitt, president of
Harch Capital Management,
Boca Raton,
Fla.,
is the
manager
of 150
bank
loans
(which
constitute
a collateralized
loan
obligation,
or
CLO,
a
species
of
CDO).
He
contends
that
the loan
structures
do
work?and
Lewitt, in his
professional
capacity,
is
a hard
man
to please.
Yes,
he
readily
acknowledges,
credit
spreads are
too
tight,
but ?even if
a
loan
defaults,
you
still
get
recoveries
of
95 cents
on the
dollar,
or even
over par, so
you are OK.?
Lewitt is
here
referring
to
senior
loans. Beware,
he says, the second-lien
kind,
which are
really
?just
bonds,
and
that?s
where you
will
have some
real capital
impairment.?
Our
investigation
leads
usto the
same
conclusion,
though
most
lenders
and
borrowers
are
wondering
less
about
capital
impairment
than
about
what took
them so
long to see
the
beauty
of
junior
bank claims.
Among
these
merits is
the
east of
early
call
(at the
borrower?s
behest
and
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with fewer
of the costs
and
restrictions
typically
associated
with
calling
a corporate
bond) and
the fact
that they
pay
a floating, not
a
fixed,
rate
of interest. Their issuance
is
soaring. According
to Steven Miller,
manageing
director
of S&P?s
Leveraged
Commentary
and
Data
Group,
16
billion
of second-lien
paper
came to
market in
2005. 35%more than
in
2004.
And while junk-bond
issuance
last
year totaled
$75 billion,
less
will
be
sold
this year.
?Furthermore,?
colleague
McCulley
observes,
?second liens
are tailor-made
for
the current
state of
the
financial
world,
hedge
funds
.
absorb 37% and CLOs 48%
of second lien issuance nowadays.
Libbey Inc.,
the
Toledo, Ohio,
glassmaker
profiled
in
the
April 21 issue
of
Grant?s,
is
among
the companies
that
has
recently
forsaken the junk
market for the
second-lien
market,
it
expects to tap
it any
day.?
What?s
there to be afraid
of?
a
practitioner
we know
rhetorically
asks: ?For
a deal
that has
locked in
its liability
costs for
in
the market
that would
bring
back
credit spreads
to
more
natural
levels.?
Be careful
what
you wish
for, we
say. The
financial engineers
are
up in
the
driver?s
seat
of credit,
a fact
that
ought to
worry
everyone
except
distressed
investors.
?[Flor
some
mezzanine
structured
credit
products,?
the aforementioned
IMF
paper
speculates,
?zero
recovery
rates
are
much
more
likely
than
on similarly
rated
corporate
bonds. yet
the
resulting
default probabilities
and
expected
losses
are mapped
into
traditional
corporate
bond ratings
that
tend to
be
in
the
40%-60%
range.?
No
default
epidemic
is
imminent,
our friend
Lewitt
asserts.
Yet,
he points
out,
something
is bound to
interrupt
the
present idyll.
Something
?systemic? is
his
nomination.
?These
hedge funds
are
not
a
sign
of health and
this
equity day
trading is not
a
sign
of health.
And
having
a
credit
market priced
on
a non-credit
basis?meaning
priced off
quantitative
and
arbitrage
bases and
not on credit
fundamentalsis
not
a
healthy
thing.?
Credit
markets
ought
to be
priced on
the
basis
of
eredit,
of
course?and,
one day,
most
assuredly,
they
will
be again.
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English
Majors? Revenge
Collateralized
debt obligations
are only
baffling
most of the
time.
Gibberish, the
technical
literature may
be,
but a
determined reader
can make
out the
occasional familiar
English
word or
phrase. One such
word
is
?assumption.? It turns
out to be of
critical
importance
to
understanding
how
these complex
structures
are
designed, priced
and sold.
Now
begins
another voyage of
discovery.
The
destination: Th e
land of
the CDOs.
The
missions:
Understanding.
W e
write on behalf
of
all
who
stand suspicious
but
mute before the
mathematical
guardians of
this 1
trillion market.
Do
you, Mr.
or Ms. Former
English
Major,
suspect that
there is
a fly in the
derivatives
ointment but are
afraid
to
express a
doubt
in
the company
of
quants? We
are
going to
arm
you
with
the
facts.
By
way of
background,
the
housing market is only
as
strong as
the mortgage
market.
And the
mortgage
market,
these days,
is
only
as
strong
as the
CDOs into
which are
packed
hundreds of billions
of
dollars
of housing-related
debt
prime
and subprime,
?cap corridor
bonds,?
Alt-A-pass-through
hybrids
and others you
may not
want
to
ask
about
just
now). And the
CDOs
are
only
as
viable as their
equity
base.
In
previous
issues, Grant?s has
described
these
securities and
the
risks that
unsuspecting
investors
may run
in holding
them.
This time
out, the
focus
is on
the junior-most
portion
of the
CDO
liability
structure, i.e.,
the equity
tranche.
It?s
the equity
that bears the
first
loss
or,
if
all goes
according
to plan,
eams
the highest
return. You
can?t sell
a CDO
without
some
sliver
of
equity?and
sliver
is the
word.
High-grade
deals are
leveraged
at 100:1 on up.
Buyers of
this
derivatives
dynamite are
said
to include hedge funds
as well as
institutions
in
Japan,
South
Korea
and Southeast
Asia.
In
March, Moody?s
performed
the
signal public
service
of
compiling
actual
returns
on
equity portions of 66 ?terminated? CDOs (i-e.,
entities
that,
for one
reason
or another,
had
reached
the end
of their
useful lives).
It
found that returns
ranged
from
a negative
82% to
a
positive
99% and
that
the median
return
was very close
to
zero.
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Moody?s
analysts
were
not dogmatic,
however,
because
they
could
not
be
sure
what
investors
had paid for
the
securities
they
were examining:
?Unfortunately,
the pricingof
equity is
the
result
of
a highly
private,
sometimes
complex
negotiation.?
In a
follow-up
study of
the equity
tranches
of 10
terminated
structured-finance
CDOs,
Moody?s
last
month
found
that returns had ranged from
a
negative
59. 1% o a positive
70. 1%,
with the
average at
a negative 8.4%.
A
curious
layman will
now
begin to
appreciate the
significance
of
the
word
?assumptions?
in the context
of
expected
CDO returns
(especially
when pricing
is as
transparent
as
a curtain of
lead).
With
enough of the
right
kind of assumptions,
the equity
-tranche
buyer
can
sleep the
sleep of
the confidently
misinformed.
But such
self-delusion
will be
a
little
harder
to achieve since
publication
of a July
26
report by
Deutsche
Bank
entitled, ?High
Grade ABS
CDOs? (in
which
ABS
stands for
?asset-backed
securities?).
The
analysis
calls
into
question
the premises
on
which
such
derivatives are
built and
sold.
?Modeling
assumptions
that simplify
actual
cash flows are
commonplace
in
the
world of
structured
finance,? the
authors note.
?However,
while these
adjustments
are
unlikely
to
significantly
impact
the
debt,
they can
have significant
consequences
on equity returns?especially
within a
structure
that
is leveraged
100
to 200
times.?
And
what
might
these
dubious
assumptions
be?
Asset
and
liability
cash-flow
mismatch, is
one. Something
having to do
with
a five-
to
seven-day
?trustee period?
at the
time
of issuance is
another, and
?risk mismatch
in
2004 CDOs?
is
a third. A
fourth
involves
the
universal
impulse
to
reach
for yield: ?In
the
current
relatively tight spread
environment,?
the
report
says, ?collateral
managers
have
increasingly
turned
to
higher
yielding
alternative prime
mortgage
products to add
additional
yield to
the CDO
portfolio.?
These
are,
or have
been, the
best
of times for
housing,
the
Deutsche Bank authors observe.
Drawing
comfort from past performance,
investors
have
come to
regard
?the
structures and
the
various
modeling
assumptions
that are
embedded
within them?
with
unwarranted
confidence.
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Especially is
confidence
unwarranted
at
a time of elevated
leverage.
?I
don?t
want to suggest
that anything
malicious
and
underhanded
is going on
here,?
Anthony Thompson,
managing
director and
head of U.S. asset-backed
security
and
CDO
research for Deutsche
Bank,
tells colleague
Dan
Gertner.
?I
think the
reality
is
that
a
lot
of the
CDO
architecture
and
technology
was
created 10 to
15 years ago
when
spreads
were wider,
leverage
was lower
and where
you
didn?t
have
to be
so
meticulous
with
your assumptions.?
Buyers
of
these
equity
pieces
are
no t
necessarily
the
world?s
most sophisticated
modelers
of
structured
finance
securities,
Thompson
adds. ?1
would
make
the
point that
mortgages are
complicated
still
to
most
of the world.
Mortgages
levered 200
times
are
even
more complicated.?
By
tweaking
some
standard
assumptions
to make them
conform
with the 2006
marketplace,
the
Deutsche
Bank study
adjusts
an ?idealized?
expected return
of 19% to a
more realistic
10.2%
return. Note
well,
however, as the
authors add,
that
CDOs are
built
on
many
assumptions
They
acknowledge
that
they
examined
?but a few
pieces
of the
complex
CDO
puzzle.?
Come the
next bear
market in
mortgage
debt,
many
more
assumptions will
certainly
come in
for reappraisal.
Knowing only
this
much,
the
detached and
calculating
English
major
might
well
be able
to
sweep up
astonishing
bargains.
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