CRMM-10-structured-credit-risk.html

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		<title>Credit Risk Measurement and Management | Chapter 10 | Structured Credit Risk</title>

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					<h1>Chapter 10</h1>
					<h3>Structured Credit Risk</h3>
					<p>
						<small>Created for <a href="http://alchemistsacademy.com">Alchemists Academy</a> by <a href="http://alchemistsacademy.com/about">MacLane Wilkison</a></small>
					</p>
				</section>

				<section>
					<section>
						<h1>Structured Credit Basics</h1>
					</section>

					<section>
						<h2>Structured Products</h2>
						<ul>
							<li>Types:</li>
							<ul>
								<li>Covered bonds</li>
								<li>Mortgage pass-through securities</li>
								<li>Collateralized mortgage obligations</li>
								<li>Structured credit products</li>
							</ul>
							<li>Often housed in bankruptcy-remote special purpose entities (SPEs)</li>
							<li>Classification dimensions:</li>
							<ul>
								<li>Underlying asset classes</li>
								<li>Type of structure</li>
								<li>How much pool changes over time: static, revolving, and managed pools</li>
							</ul>
						</ul>
					</section>

					<section>
						<h2>Capital Structure and Credit Losses</h2>
						<ul>
							<li>Capital structure is broken into distinct tranches</li>
							<ul>
								<li>Equity</li>
								<li>Junior debt</li>
								<li>Senior debt</li>
							</ul>
							<li>The boundary between tranches is referred to as the "attachment point"</li>
							<li>The portion of the capital structure below a tranche is referred to as its credit enhancement</li>
							<li>Overcollateralization is the technique of selling a par amount of bonds that is less than the par amount of underlying collateral</li>
						</ul>
					</section>

					<section>
						<h2>Waterfall</h2>
						<p><em>Definition: The rules governing how cash flows are distributed to the various securities in the capital structure</em></p>
					</section>

					<section>
						<h2>Issuance Process</h2>
						<ul>
							<li>Players:</li>
							<ul>
								<li>Loan originator - original lender who creates the debt obligations in the collateral pool</li>
								<li>Underwriter - aggregates the underlying loans, designs the securitization structure, and markets the liabilities</li>
								<li>Rating agencies - assess the creditworthiness of the liabilities and assign a rating</li>
								<li>Servicers and managers - collects principal and interest and disburses it to the liability holders</li>
							</ul>
						</ul>
					</section>
				</section>

				<section>
					<h2>Credit Scenario Analysis</h2>
					<ol>
						<li>Track the interim cash flows</li>
						<li>Track the terminal year cash flows</li>
						<ul>
							<li>Loan interest from surviving loans</li>
							<li>Proceeds from redemptions at par of the surviving loans</li>
							<li>Recover from defaulting loans</li>
							<li>Value of overcollateralization account</li>
						</ul>
					</ol>
				</section>

				<section>
					<h2>Simulating Structured Credit Risk</h2>
					<ul>
						<li>Procedure:</li>
						<ol>
							<li>Estimate parameters</li>
							<li>Generate default time simulations</li>
							<li>Compute credit losses</li>
						</ol>
						<li>Key characteristics:</li>
						<ul>
							<li>Increases in the default rate increase bond losses and decrease equity IRR</li>
							<li>Increases in correlation has varying effects, depending on the level of defaults</li>
							<li>At low correlations, equity values exhibit positive convexity in default rates and the senior bond tranche exhibits negative convexity in defaul rates</li>
						</ul>
					</ul>
				</section>

				<section>
					<h2>Structured Credit Risks</h2>
					<ul>
						<li>Systematic risk</li>
						<li>Tranche thinness</li>
						<li>Granularity - diminishes concentration risk</li>
					</ul>
				</section>

				<section>
					<h2>Default Correlation Concepts</h2>
					<ul>
						<li>Default correlation - correlation concept most directly related to portfolio credit risk</li>
						<li>Asset return correlation - correlation of logarithmic changes in two firms' asset values</li>
						<li>Equity return correlation - correlation of logarithmic changes in the market value of two firms' equity prices</li>
						<li>Copula correlation - the values entered into the off-diagonal cells of the correlation matrix used in the copula approach</li>
						<li>Spread correlation - correlation of changes in the spreads on two firms' comparable debt obligations</li>
						<li>Implied credit correlation - estimate of the copula correlation derived from market prices</li>
					</ul>
				</section>

				<section>
					<h2>Structured Credit Motivations</h2>
					<ul>
						<li>Issuer:</li>
						<ul>
							<li>Maturity matching</li>
							<li>Aribtrage</li>
							<li>Balance-sheet relief</li>
						</ul>
						<li>Investor:</li>
						<ul>
							<li>Access to diversified loan pools</li>
							<li>Risk sharing via tranching</li>
							<li>Embedded leverage</li>
							<li>Yield chasing</li>
							<li>Regulatory arbitrage</li>
						</ul>
					</ul>
				</section>

				<section>
					<h1>THE END</h1>
					<h3><a href="http://alchemistsacademy.com">AlchemistsAcademy.com</a></h3>
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