Introduction to Securitization

KEY POINTS OF THE CHAPTER

• For all CDOs (balance sheet, arbitrage, cash, and synthetic), investors and rating agencies must assess and monitor the quality of the asset pool.

• The quality of the asset pool is measured by two types of tests: asset quality tests and diversity tests.

• Asset quality tests include (1) weighted average rating factor test and (2) minimum and maximum weighted average coupon test.

• The weighted average rating factor (WARF) is a numerical score developed by rating agencies as a measure of the rating quality of the asset pool.

• The weighted average coupon (WAC) test requires that the assets in the portfolio not fall below a specified minimum rate nor exceed a specified maximum rate.

• Diversity tests include (1) concentration limits and (2) minimum diversity score.

• Concentration limits impose limits on the percentage concentration in a particular asset, particular sector, cluster, geographical region, and so on.

• The diversity score is a measure developed by Moody’s to quantify the extent of diversity in a pool.

• Asset and income coverage tests involve overcollateralization and interest coverage triggers that serve as automatic deleverage triggers for a CDO.

• Minimum asset coverage test is provided by the overcollateralization (OC) test, which is imposed as a precondition for the CDO manager to continue to make reinvestments and hence maintain the leverage of the transaction.

• There are OC tests for various bond classes of rated liabilities, ...