大浩浩的笔记课堂——FRM考试学习笔记107

Topic 36 The Credit Transfer Markets and Their Implications

1.Background:

⑴The root causes of the misalignment were:

①the flawed computer models at the rating agencies

②the profit motive of the rating agencies

③pressure from the originators

④the drive for market share coming from the rating agencies

⑤the rating agencies lack of provided resources to conduct the proper due diligence

⑥the absence of meaningful public oversight

⑵the major contributors to the crisis:

①bank leverage,poor origination practices,the financial firms role

②misaligned incentives along the securitization chain,driven by the search for short-term profits

③lack of transparency about the risks underlying securitized products

④poor management of the risks associated with the securitization business

⑤over reliance on the accuracy and transparency of credit ratings

2.Why credit risk transfer is revolutionary if correctly implemented:

⑴"traditional" credit risk enhancement techniques:

①bond insurance

②guarantees(including letters of credit)

③collateral

④early termination

⑤reassignment(assign one´s position as a counterparty to a third party of a ratings downgrade in the event)

⑥netting

⑦marking to market(sophisticated monitoring and back-office system)

⑧put options

⑵the problems of traditional mechanisms:

①They lack flexibility.

②They do not separate the credit risk from the underlying positions→credit derivatives(e.g.CDS)

⑶Securitization gives institutions the chance to extract and segment a variety of potential risks from a pool of portfolio credit risk exposures and to sell these risks to investors.

⑷In a mature credit market,credit risk is not simply the risk of potential default,it is the risk that credit premiums will change minute by minute.

3.How exactly is all this changing the bank credit function:

⑴traditional originate-to-hold(OTH) model:

①holding and "owning" credit assets:

Credit assets are retained at the business unit level.

②Risk assessment is mostly limited to expected loss(EL) and ignores unexpected loss(UL):

A.EL:It is priced into the loan in the form of a spread charged to the borrower above the funding cost of the bank.

B.UL:

Banks hold capital.

③Risk management is limited to a binary approval process at origination:

A.Originating a loan using a binary approval process and then holding ht loan until maturity.

B.Lender retains all credit risk and loan origination process will therefore be more stringent.

⑵originate-to-distribute(OTD) model:

①Loans are divided into:

A.core loans:

Bank holds over the long term→managed by the business unit

B.noncore loans:

The bank would like to sell or hedge→credit portfolio management group

②Economic capital:

It is the key to assessing the performance of a bank.

③credit portfolio group:

A.credit portfolio management:

a/ increases the velocity of capital

b/ reduces concentration and event risk

c/ increases return on economic capital

d/ responsible for financial,but not a profit center 

e/ hedges and trades retained credit portfolio

f/ houses "public side" research analysts,portfolio managers,traders

B.counterparty exposure management:

manages counterparty risk of derivatives exposures

C.credit portfolio solutions:

provides advice to originators on structuring and credit risk mitigation

④OTD models have produced 3 primary benefits:

A.Loan originators enjoy increased capital efficiency and decreased earnings volatility.

B.Investors have a wider array of diversification options for the fixed income portion of their portfolios.

C.Borrowers have expanded access to credit and lowered borrowing costs.

·特别注意！

·There were 3 key underlying flaws in the securitization process that led to the 2007—2009 financial crisis:

*Members of the securitization supply chain were incentive to find borrowers.Sell them a loan,and package that loan for resale without retaining any default risk,this led to lax lending standards.

*The securitized products themselves were very opaque.

*Financial institutions´ use of off-balance-sheet techniques to hold securitized loan further disguised the risk spectrum from investors.

⑶traditional credit function(OTH model) vs. portfolio based approach(OTD model):

4.Types of credit derivatives:

⑴credit default swaps:

①credit events:

A.bankruptcy,insolvency,or payment default

B.obligation acceleration

C.stipulated fall in the price of the underlying asset

D.downgrade in the rating of the issuer of the underlying asset

E.restructuring

F.repudiator or moratorium

②default payment:

A.par minus post default price of the underlying asset

B.par minus stipulated recovery factor(60% for a bank loan,40% for a bond)

C.payment of par by seller in exchange for physical delivery of the defaulted underlying asset

③benefits of using CDS:

A.To divorce funding decisions from credit risk-taking decisions.

B.It is easy to make leveraged transactions because CDS are unfunded.

C.CDSs are customizable.

D.To improve flexibility in risk management.

E.for banks:reduce risk or free up capital

F.To take a spread view on a credit.

G.new "relative value" opportunities(e.g.trading the default swap basis)

H.To divorce the client relationship from the risk decision.

I.To bring liquidity to the credit market.

⑵first-to-default CDS:

①example:

It will automatically be compensated if one of the loans in the pool of 4 loans defaults at any time during this period,the bank is compensated only for the first loan that defaults.

②function:

First-to-default structures are pairwise correlation plays the yield on such structures is primarily a function of:

A.the number of names in the market

B.the degree of correlation between the name

③generalization:

nth-to-default credit swap:

It is where protection is given only to the nth facility to default as the trigger credit event.

⑶total return swaps(TRSs):

①In contrast to a CDS,both market and credit risk are transferred from the seller to the buyer.

②They can be applied to any type of security,and the maturity is much shorter than the underlying assets(like a loan,stock,or even a portfolio of assets).

③example:

A.bank,seller of credit risk,payer→total loan return(coupon+price appreciation)→buyer,buyer of credit risk,receiver

B.bank,seller of credit risk,payer←LIBOR+x bp+price depreciation←

buyer,buyer of credit risk,receiver

④TRS is equivalent to a synthetic long position in the underlying asset for the buyer.It involves no exchange of principal,no legal change of ownership and no voting rights.

⑤In order to hedge both the market risk and the credit risk of the underlying assets of the TRS,a bank that sells TRS typically buys the underlying assets.

⑥The risk of default of the buyer in TRS will depend on the degree of leverage adopted in the transaction.

⑷asset-backed credit-linked notes(CLN):

①definition:

It is a debt obligation with a coupon and redemption that are tied to the performance of a bond or loan,or to the performance of government debt.

·特别注意！

·So,they get exposure to the loan without actually investing in the loans.

②characteristic:

It is an on-balance-sheet instrument,with exchange of principal,there is no legal change of ownership of the underlying assets.

5.Credit risk securitization:

⑴Introduction:

securitization of corporate loans and high-yield bonds:

①Collateralized debt obligations(CDOs) is defined:

General term for an asset-backed security that issues securities that pay principal and interest from a collateral pool of debt instruments.

·特别注意！

·SPV guarantee that the originator has norecourse for losses sustained 

after an investor purchases a securitized assets.

②Collateralized debt obligations(CDOs) is including:

A.synthetic CDO

B.single-tranche CDO

C.structured finance securities:

such as CLOs,CBOs,MBSs,cash CDOs and related instruments

⑵synthetic CDOs 合成CDO：

①概念：

其是指债券持有人承受标的资产的经济风险，但并不对这些资产拥有法律上的所有权。这是通过将某种或者有支付参与资产联系起来实现的。

②process:

A.Originator retains reference assets on balance sheet but transfers credit risk on an SPV,which then creates tradable CDO.This product bets on default of a pool of assets not on the assets themselves:

a/ They are custom-made instruments for a specific transaction.

b/ Each tranche may trade separate from the rest of the capital structure.

B.The sponsoring institution transfers the credit risk of the portfolio of creditassets to the SPV by means of the CDSs,while the assets themselves remain on the balance sheet of the sponsor.

③characteristics:

A.Sell CDS

B.Buy high quality asset

C.Off-balance sheet

D.No operational risk

E.No standardized tranche widths

⑶single-tranche CDOs:

①definition:

In a single-tranche CDO,only a particular tranche,tailored to the client´s needs,is issued.

②characteristic:

highly customizable:

Investors can customize their maturity,coupon,collateral,subordination level and target rating.

③the biggest advantage and disadvantage:

A.the biggest advantage:

It allows the client to tailor most of the terms of the transaction. 

B.the biggest disadvantage:

the limited liquidity of tailored deals

⑷the special case of subprime CDOs:

①definition:

They were based on structured credit products such as tranches of subprime residential mortgage-backed securities or of other CDOs.

②characteristic:

A subprime CDO is a CDO squared:

residential mortgages→RMBS securities→mezzanine ABS CDO

③structure:

A.75%→triple A

B.20%→the mezzanine

C.5%→equity tranche

⑸re-remics:

Re-remics consist of re-securitizing senior MBS tranches that have been down-graded from their initial AAA rating.

⑹CLOs and CBOs:

①collateralized loan obligations(CLOs):

They are specialized form of CDO that only invests in bank loans.

·特别注意！

·The originating bank will retain the equity tranche to keep a small amount of skin in the game.

②collateralized bond obligations(CBOs)

③CLOs and CBOs:

A.A CLO or CBO is potentially an efficient securitization structure:

Because it allows the cash flows from a pool of loans or bonds rated at below investment grade to be pooled together and prioritized.

B.the main differences between CLOs(easier to produce notes) and CBOs:

a/ the assumed recovery values for

b/ the average life of

c/ the underlying assets

④characteristic:

A.Customized baskets of debt instruments segregated broadly into senior,mezzanine,and equity tranches.

B.The credit enhancement of the senior secured class notes is obtained by simply shifting the default risk to the equity tranche.

⑺credit derivatives on credit indices:

①There is less activity for index tranches.

②Index trades are also popular with rollers of CDS tranches and CLNs who need to hedge their credit risk exposure.

③The 2 major families:

A.CDX→North American and emerging markets

B.iTraxx→European and Asia

④3-,5-,7-,and10-year maturities,a new series is laundered every 6 months on the basis of liquidity.

⑤The quotation of each tranche is made of 2 components:

A.the "upfront" payment

B.fixed "coupon" paid on a quarterly basis

6.Summary of credit risk mitigation techniques:

⑴bond insurance:

Purchasing insurance.

⑵collateralization(largest running form):

The losses sustained by the lender will be offset by the value of the collateralmeanwhile considering liquidity factor.

⑶termination:

A certain trigger event,such as a downgrade,has occurred and the issuer was obligated to repay the loan early.

⑷reassignment:

Giving the right to assign one´s position as a counterparty to a third party.

⑸netting:

Net replacement value represents the true credit risk exposure.

⑹marking-to-market:

Periodically acknowledging the true market value of a transaction.It will result in immediately transferring value from the losing side to the winning side of the trade.

⑺loan syndication:

Multiple lenders all working together as a team to provide funding to a given borrower.

⑻outright selling(secondary market transactions):

It is the outright selling of a loan portfolio in the secondary market.

大浩浩的笔记课堂之FRM考试学习笔记合集