New

York

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2001

J.P.

Morgan

Structured

Douglas

Lucas

doug/as..

Global Structured

Securities

Global

Finance

Inc.

Finance

1-212

lucas@chase.

JPMorgan

Research

834-5535
corn

www

Research

earn

morganrnarkets

CDO Handbook
Overview
CDO

Global

issuance

and

public

private

given that

the

CDO

the

of

level

$4 billion

billion.

for the
is

figure

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to

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information

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concerning

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Blooinberg.

these

and

other

restrictions

report.

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J.P.

Global

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CDO

Inc.

Finance

Structured

Research

Handbook

JPMOrgafl

Page

834-5535

1-212

Introduction1
person new

collateralized

to

debt

CDOs

obligations

is

faced

with bewildering

terminology

CBO
CDO
CBO of ABS

Balance

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can

to

and

issue

can

be guaranteed

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The

CDOs

credit

names above
one

described

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structures

are

done

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think

made with

by the choices

loans

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to

way

to

respect

market debt
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and

CDO

and

features

and

purposes

use

credit structures.

both classify

carte approach.

draw

delay

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structure

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forms

of ways with respect

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and

emerging

assets synthetically.

of two

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the easiest
la

or

component

for

combination

or

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by taking

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of Real Estate

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variety

bonds

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obligations

rate

obligations

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distinct

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by

of two

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CMBS.

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floating

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at

an existing

The
of

next

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conceptual

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describes

paper

allow future

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way

paper discusses
the

provide

flexible definition

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through twelfth

fifth

stand alone

of current

they

Why

CDOs

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Market
Cash

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be placed in the context

of

exist

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structural

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components.

fourth

section

CDO structures existing today or to stretch the menu

CDO combinations.
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two sections
we hope to

CDOs
of

sections

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interest.

to

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are

innovations

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read

sections

and

why

and

this

in

any

of current

description

report
order

address

and

specific

sections

market practice.

CDO

can be

The

topics.
if

skipped

sections

they are not

are
do

investors

buy

them

value credit structure

flow credit structure

CDOs

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Parties

CDO

to

Legal considerations
considerations

Accounting
Tax

considerations.

Theauthor
Roger
preparing

would

Merritt
this

Pat

like

to

OBrien

thank
Allen

Ade

Adetayo

Reiser Marie

Andrew
Stewart

Chalnick
David

Jeremy

Tesher

Gluck

Katrina

Bob
Tormey

Grossman
and Lenny

Ji-Mei

Ma

Zuckerman

Bill

Ma

for

their

Edward
generous

Mayfield
help

in

report.

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useful

articles

Research

the

Handbook

JPMorgan

Page

834-5535

Notes

and

Glossary

removed from

CDO

Inc

Securities

Structured

section

main concern

published

defines

by rating

terms in the text and

italicized

The two

of the paper
agencies

and

final

sections

names of

the

CDO

discusses

topics

of the report

list

asset

and

managers

asset sellers

Please

note

that

issues

obligations

to

seemingly

the

encompassing

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CDO

the

refers to

circular
various

also

the special

phrase the

CDO

vehicle

purpose

refers specifically
issues

subclasses including

to

CDOs

the

SPV

the obligations

CDO

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species

that

holds

SPY

the

CDO
listed

is

assets
issues

and
leading

an umbrella term

above

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Inc

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Research

Handbook

wiPMorgan

Page

834-5535

1-212

Purposes and Credit

Assets Tranches

Structures

Assets
Its

more than

assets

commercial

re-securitized

Even

market debt

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for

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bonds

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1987

than

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up

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securitization2

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Service

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Global

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CDO

Inc.

Finance

Structured

Research

Handbook

PMorgan

Page

834-5535

1-212

Chart

CDO

Typical

Tranching

TRANCHES

RATINGS

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Rate

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banks which

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J.P

Lucas

desire

to

balance

CDO
CDO

assets or transfer

sell

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is

assets
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and

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capital as balance

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JPMOrgafl

of assets

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regulatory

way

variety

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the

required

straightforward

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Handbook

Page

834-5535

1-212

synthetically

adjust

Research

sheet reduce

The most

but

Finance

Structured

Douglas

CDO

Inc

Securities

Morgan

Global

accomplished
equity

most
close

or

all

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balance

sheet

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2001

J.P

Lucas

Credit

CDOs

CDO

haircut

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default

no

is

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default

probability

flow structuring
tranches

technique
of

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either

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assets are

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Handbook

Page

834-5535

1-212

can have

the

assets

Research

Structures

CDO
way

or

Finance

Structured

Douglas

CDO

Inc

Securities

Morgan

Global

CDO

senior

never

generally

both by number and

volume

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to

CDO Menu

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JPMorgan

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May 29

2001

Securities

Morgan

J.P.

Global

Lucas

Douglas

CDO

Inc.

Finance

Structured

Research

Handbook

JPMOrgafl

Page

834-5535

1-212

Typical Structures

CDO

The two ways

two

CDO

main

can

gain

without

however
at

done

is

purpose

with that

ironic

structure.

five

CDOs

illiquidity

The

market value

reduces

shares

by value of assets

Market

assets.

balance

sheet

because

it

interests
respect

credit

the

structures

two

times

two

times

value transactions
and

purposes

have

not

been

in

1987

and

and

CDO

done

greater

to

synthetic

doomed

CDO

balance-

the

securitization

combinations

five.

to

CDOs.

from 1987

issuance

arbitrage

Here

through

1988

in

Evolving

leverage.

would have

probably

sheet

that

introduced

almost always cash asset and

are

structural

of total

allowed

balance

the

1988 combined

prevented their use in market value

assets has

transactions

out

done

ever

With

anyway.

number of

the

CDOs two

But the cash flow credit structure

of synthetic

comparative

CDOs

of

types

or synthetically

CDO

two

the

market value credit structure

CDOs

CDO

for retained

market-value

that

the

credit

standards

fact

for

market value approach

accounting
sheet

between
first

superseded

eight

of underlying

now

as the

the

sheet and

assets.

correlation

negative

purpose

types

by cash purchase

assets

balance

lead to

least

at

yet with synthetic

least

The

never

are

would

different

considering

or

arbitrage

purposes

cash flow or market value

to

exposure

purpose

are their

2000

market

of half

dollars

trillion

Table

Structure

Cash

Percent

Cash

arbitrage

balance

Cash

flow

the

through
the

flow

41%

first

Corporate

reigned
In

cash-flow

the assets

CDOs.

The
of

history

10%
Watch

briefly

1996

9S9

in

CDO

arid

CDOs

before

Bloomberg.

in

arbitrage

rose

to

$36

1987

and

1988

cash-flow

CDO

issuance

cash-

took over from

more than twice

billion

The explosion of

balance-sheet

CDOs

was

led

the

1990

volume of

by balance-

CDOs.

was

side 1996

also

former assets were

CDOs

CDO

SP

Moodys

issuance

combined.

loans

have

ABS/RMBS/CMBS-backed
market

Fitch

market-value

balance-sheet

1995.

9%

flow

cash
value

previous nine years

sheet

On

4%

cash

MCM

JPMorgan

CDOs

flow

sheet

2000

36%

cash

market

arbitrage

Sources

After

sheet

balance

Synthetic

Volume 1987

flow

cash

arbitrage

Synthetic

of

issuance

the

been

CDOs

peaked

first

associated
the

CDOs

time loan-backed
with balance-sheet

most prominent

are currently

asset

increasing

exceeded

cash-flow
followed

bond-backed

CLOs.

Over

the

by bonds.

market share

while emerging

in 1997.

Table

Structure

Percent

of

Volume 1987

Loans

63%

Bonds

25%

ABS/RMBSCMBS
Emerging
Sources

9%
3%

market

JPMorgari

2000

MCM

Corporate

Watch

Fitch

Moodys

SP aid

Bloornberg.

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May 29

2001

J.P.

Lucas

1-212

CDOs

While
balance

CDO

Inc.

Finance

Structured

Douglas

are

Securities

Morgan

Global

Research

JPMorgan

834-5535

by commercial

sponsored

CDOs

sheet

Handbook

Page

loans

almost always found

in

banks

are also

large

arbitrage

CDOs.

have

caused

in

factor

loans

to

he the primary asset for

CDOs.

arbitrage

in contrast

Bonds

Table

Structure
Cash and

Percent

synthetic

cash

arbitrage

of

Volume 1987 -2000

flow

19%

Bonds

16%

Loans

3%
2%

market

Enierging

ABSRIvIBSICMBS
Cash and

balance

synthetic

flow

cash

sheet

Loans

45%

Bonds

3%

ABS/RMBS/CMES
Cash

arbitrage

2%

market

value

ABSRMBS/CMES

4%
3%

Loans

3%

Bonds
Sources

MCM

JPMorgan

Table

Watch

Corporate

SP

Moodys

Fitch

goes into more detail on these

typical

arid

Bloomberg.

CDO

structures.

Table

CDO

Structural

Prix Fixe

Menu

Arbitrage
Purpose

Arbitrage
return

Cash Flow

Balance

Sheet

Leveraged

Balance

sheet Reduce

Arbitrage Leveraged

balance

sheet

return

to equity

holders

economic

term

non-recourse

fees

financing

via

to asset

Cash

Flow

or required

and

via

regulatory

capital

so that

default

interest

principal

Cash

Subordination

sized

is

after-

assets

repay

of

assets

Assets

flow

sized

are
or

after-default

debt

principal

in

purchased
secondaiy

Asset manager

interest

repay

sold

assets

and

asset

The

or insurance

Emerging
decreasing

bonds

grade

coIilliercial

sheet

fmancial

Commercial

Bank

loans

market

debt

loans

smaller
is

and

market

the

if

assets

are

tranches

declines

value

too

much

balance

single

Assets

debt

of

Assets

institution

bank

are

primary
market

purchased

sometimes

companies.

Asset manager

Some bond

to

Wide range of

assets

convertibles

and

equity

or

company

including

and

in

or secondary

insurance

Speculative

and

term
to

value

and

repaid

of

debt

company
Assets

holders

fees

Market

Subordination
that

so

tranches

primary
market

Sponsor

is

and

tranches

Source

Value

manager

Cash flow

structure

to equity

non-recourse

financing

manager
Credit

Market

Arbitrage

distressed

debt

ABS/IUVIIBS/CMBS

ABS/RMIBSICMBS

i5

collateral

nicreasing.

Cash

versus

synthetic

exposure

May have
exposures
cash
assets
completely

Special

tranche

features

May have
tranche

as

purchased
period

few

synthetic

among dominant
or

Increasingly
completely

Hardly

are
synthetic

ever

has

synthetic

exposures

be

synthetic

delayed thaw

May

have

assets

are often

tranche

over

ramp

revolving

up

to

revolving

acconmiodate
bank

loans

to

Likely
revolving
assets

meet

have
tranche

are adjusted

OC

as
to

tests

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2001

J.P.

Morgan

Global

Securities

Lucas

Douglas

Inc.

Finance

Structured

1-212

Research

CDO

Handbook

Page

10

JPMOiafl

834-5535

Table

CDO

Structural

Prix Fixe

Menu

Continued
Cash Flow

Arbitrage
investors

Equity

Some

retained

by

asset

to

Interest

rate derivatives

12

Deal

size

rate

$200

400

Tenor

to

bonds

600

activity

rate assets

floating

for

Trading

20

times

Swaps and caps often

used to bridge
between
fixed

and

million

by

asset

50

times

used

usually

assets

are

to

since

typically

rate

floating

retained

$1

by

asset

times

Swaps and caps often

used to bridge
between
fixed

to

10

$500

billion

and

rate assets

floating

rate

liabilities

million

to

billion

for loans

Little

followed by

seven

years mezzanine
Caflable

or

Based
of

amortization
seven-year
Senior
tranche
period.
life

Some

Value

manager

to

Not

Arbitrage Market

.5

rethvestment

Five-year

years.

retained

Flow

to

Restricted

average

Cash

liabilities

$300

million

period

Often

Sheet

seller

manager
Leverage

Balance

none

Greatest

on remaining

original

duration
instrument

of

assets

or

synthetic

life

Five

year

life

amortization
three

months.

after

two

10-13

the

last

Callable

or three

with premium

to nine

with
over

to

years
fixed

rate tranches.

after

with premium
years
to fixed rate tranches.
three

Market

Source

share

by volume

40%

50%

10%

JPMorgan.

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May 29

2001

Securities

Morgan

J.P.

Global

Lucas

Douglas

Research

of the

The

questions

cost

of

accountants.

Why

believe

cannot

it

CDO

separates

most

suited

The

the

of

price

and

the

investor

professionals
tranches

has

that

pay

structure

CDO

Some

of

its

more than

custom

creates

investors

are

advantage
into

more

and

attorneys

the

CDO

holds

investors

desire

assets the

into investors

fit

efficient

various

and

sells

each

risk

of speculative-

holders

The

assets.

holding investment-grade

tranches

the

with the

exposures that

exposures

exceeds

tranches

associated

agencies

rating

cost

custom

portfolio

tranches

amount
price

entered

steadily

These

the

bounded

is

CDO

is

entice

to the

investor

business

risk in

its

CDOs.

and

the

At

CDO

As more

form.

distilled

declined

within the above-described

declined

to create

by the utmost value each

have

fees

of the

by the cost

professionals

bounded

their preferred

CDO

low end

the

at

to

necessary

of the

on receiving

places

that

CDO

of

the cost

professionals

risk.

minimum

have

CDOs

comparative

credit risk

high end the aggregate

tranche

buy

way.

some have

hold that

to

to

goes

CDO

the

any other

the

aggregate

collateral

investors

capital constraints

and

assets

grade

do

because

is

from the recognition

difference

firms asset managers trustees

achieve

and

appetites

arise

The

assets.

security

and

Them

Buy

Investors

Parts

transaction

We

JPMOrgafl

Why Do

and

Exist

above

CDO

Handbook
11

834-5535

1-212

Why Do CDOs
The Sum

CDO
Page

Inc.

Finance

Structured

cost

of

CDO

bounds.

Equity Investors
In

of the

financing
tranche

holders

claim against
short

between

the
the

debt

no

recourse
tranche.

the creditor
debt.

compare

yield

the

on

yield

to

on

to

the

the

on U.S.
is

CBO

borrower

purpose

assets

and

rough

and

perform

assets

if

to

bonds

measure

reduced

assets

is

non-recourse term

and

poorly debt

make

cannot

repo market where

the collateral
gain

the financing

high yield

is

assets

to the

contrast

holders

CDO

This gross spread

calls

in

is

recourse

the difference

holders.
subject

has

than to

other

achieve

to

CDOs
the CDO

If the

assets.

This

Equity tranche

tranches.

equity

losses and

have

allow investors

tranches

underlying

after-default

we

Chart

CBO
CBO

equity

CDOs

the equity

term and

extinguish

In

CDO

an arbitrage

to the

cost

of the gross

by fees trading
de-leveraging

due

to

leveraged return
debt

of funds

spread

losses

is

insufficient

is

favorable
cost

further

financing

tranches.

raised

available

and

via
to

default

of the CBO.

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2001

J.P.

Securities

Morgan

Global

Lucas

Douglas

CDO

Handbook

Page

12

Inc.

Finance

Structured

Research

JPMOrgafl

834-5535

1-212

Chart

Gap

Normalized Funding

Between

High

Bonds

Yield

CDO

and

Tranches

10

We

take

CBO
by

bonds.

We

Yield

High

this

yield

10%

triple-A

from

scale

Index

asset

gloss

70%

of

on

results

asset spreads

premium.

liquidity

zero

to

ten

and

suppose

CBO

funding

5%

single-A
the

setting

an

CBO

assuming
and

triple-B

5%

historical

highest

of

distribution

asset

costs

The purchase

of the equity

asset class

second

decision

favor

in

Balance

and

economic

double-B

50%

double-B

funding

to

equal

and

50%

our

traders

avoid

false

by

We

tranches.

gap

bonds

supplied

spreads

and
precision

ten.

decision

similar

the

to

decision

of an

Debt

compare

favorably

The

premiums.

liquidity

what

irrelevant

is

premium and

matters

the

is

CDO

is

decision

first

of leverage

relative

to

of the underlying

in favor

that

and

asset class

finally

by

and

those

hedging

and

by an

asset sellers

and

the availability

considerations.

In

arbitrage

equity

capital guidelines

credit

default

In

holder.

for

CDO

These

swaps.

future balance

commercial
two

banks

factors

of

balance

view

the longer

the

working

expense

with the intent to securitize them in

assets

basket

are driven

considerations

sheet

sheet

very

is

issuance

and the growing

will

the

change

cost

assets.

Investors
tranche

almost

all

example
deals

in asset prices

time of execution

new Basel

the

use of single-name

Debt

of

in favor

of managing
gather

and

and

risk

capture

risk

credit losses

experienced credit losses.

capital

to

affected

of holding

the

at

regulatory

sponsors

be

embedded

credit losses

actual

of the manager.

methods

alternative

bet that

will also

they

tranche

decision

CDOs

sheet

holders

and

expected

of expected

comprised

that

credit losses

between

difference

and

losses

of expected

level

are

tranche

Equity

credit

expected

will

from

JPMorgan

Theoretically

to

JPMorgan

comprised

the

standardizing

the

subtract

structure

capital

Source

from

data

yield

single-B

investors

corporates
in the

first

were priced

high yield

four

from

debt-backed

55 basis points

are attracted

and

above

many
months

about

CDOs

to

CDOs

asset-backeds

17

of 2001
to

because

of their higher

of the same maturity

seven-

30 basis points

of the same maturity

to ten-year

above
and

yields

and

AAA-rated

Libor.
rating

During

ranged

as

compared

rating
credit
the

in price

to

For
card-backed

same

period

from

43 to

Libor.

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2001

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Finance

Structured

Lucas

Douglas

Inc

Securities

Morgan

Global

Research

CDO

Handbook

Page

13

JPMorgan

834-5535

1-212

Chart

AAA CDO
YTD

2001

Spreads

USD

to

Libor

Issuance

basis points

70
60

30
20
10
11

Weighted

HYBL
Source

in

Years

IGBL

J\/IX

UK

Loans

JPMorgan

ABS

Like

loss to

recovery

investors

that

now

The

additional

debt

tranche

likely

But

it

defaults

debt

comparison

might sustain

the

tranche

is

of one

And

If

still

debt

have

of each

credits

drastic

been

and

has

be

so

little

small

bond

sustains

defaults

in

bit

high that the

collateral

loss

bond

measured

recent

by

default

CDO

debt

of the names in
of multiple

comprised

relatively

corporate

as

every one

portfolio

of incremental

loss

to

default

corporate

average

tranche

supported by

of those

narrower

an individual

of par on

asset portfolio

performance

the probability

to the

relatively

CDO

for

have

tranches

47%

high

quite

CDO

in the

debt

bonds

corporate

possible

is

upon

default

return

CDO

tranches

usually

is

depends

The

portfolio

In

debt

than individual

study.L

Suppose
tranche

MBS

and

distributions
the

ABS

WA

Life

Average

effect

percentage
defaults
if

it

is

its

credits

less

defaults

and

on
less

CDO

mild default

Chart

CDO
2001

Spreads

YTD

to

USD

Libor

Issuance

basis points
800
700

..

600
500
400
300
200

AS

A1

100

XXXQC
11

Weighted

BB
Source

Average

in

sA

13

Years

XAA

XAAA

JPMorgan

Hamilton
February

BBB

Life

David

et

al Default

and

Recovery

Rates

of Corporate

Bond

Issuers

2000 Moodys

Investors

Service

2001

BARC0023970

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2001

J.P

Lucas

Because

1-212

Research

on

loss in the

default

an expected
event

of default

debt

tranches

exposure

to

new

asset class

exposure

to

CDO
new

The

would

debt

seem that investors

into

spectrum

tranches

therefore

By

provides

while

the

prefer

the

Middle

equity

the

and

bonds

same expected
gain

regulatory

must

tranches

probability

in the

risks

grade

grade

by providing

portfolio

first

investment

securitization

liquid
risk
to
credit

and

The

stretches
is

cannot

investor

loss protection

gain

offered

with exposure

investor

via
to

credit quality

grade

to

creditworthy

portfolio
loss but

who

of equity
improve

either

rated

highly

of consumer

and

triple-

and

corporate

the credit quality

assets across

of the middle

re-securitization

triple-B

middling credit quality into triple-A to unrated

stretched

investor

investor

The

tranches

equity

credit quality

barbell

taking

liquidity

both those

the

investment

the

initial

approach

of high yield

than through

middling credit quality of these

securitizations again

of highly

debt

product of default

extremes of credit risk

The

that

and

CDO

and

the

an investment

maintaining

still

They may be

credit

is

incorporates

definition

This does not mean however

portfolios

loss

quality

assets other

triple-A to unrated

of these

tranches
equity

stretches

bonds

corporate

Expected

Quality

double-A credit or unrated

obligations

and

tranche

or countries

Credit

Stretching
It

CDO

industries

JPMOrgafl

may help diversi1 an investment

grade

speculative

basis

credit

CDO

Finally

Handbook
14

seventies

loss

of an investments

evaluation

CDO
Page

834-5535

of their different

be compared
and

Finance

Structured

Douglas

Inc

Securities

Morgan

Global

and

portfolios
credit

and

assets

changes

CDO

stretched

are also
liquidity

heading
risk

from

portfolio

and

eliminate

the

extremes

for the

extremes

by constructing
of concentrated

along side positions

tranches

liquidity

into

again

completely

Treasuries

comprised

might maintain

extreme downside

credit

risk

capital relief

BARC0023971

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2001

Securities

Morgan

J.P.

Global

Lucas

Douglas

Research

Market Value Credit

Rate Mechanism

As

briefly

discussed

the

ability

value

by advance

rates

performing
performing

bank

high-yield

bonds

advance
par and

expressed as

support
the

decline

CDO

the

diverse

debt

shows

The sum of
the

each

Market

If

CDO

CDO

to

these

methods

advance

may

holders

Market

asset values

equity

and

accrued

percentage
net

It

anticipated

is

voluntary

worth

and

test

Performing

high-yield

bonds

rated

bank

loans

valued

0.895

85%

0.790
0.800
0.760

than

less

bonds

high-yield

rated

85%

0.630

Caa

0.500

Bonds

0.400
0.380

equities

Moodys

Service

Investors

caused
and

test

its

must

OC

CDO

have

debt

CDOs

sale

sell

quarterly

than

normal

the

fall

If net

course

tranche

below

this

CDO

cannot

of default

worth test

par

par

and

itself

accrued

requirement

regains

right

and

accrued.

contribute

and

interest in

market value

minimum

can

net

the
assets to the

by either of

senior-most

tranche

worth being the value

of collateral

of the

market value over the par

worth becomes too small in absolute

must also be

sold

while the

final

until

CDO

market value

of assets over the

tranche

Debt

CDO

accrued

assets

assets.

net

CDO

and

par

debt

of the

as the excess

tranches

CDO

five-industry

assets until the structure

If the

its

tranche

sum of each

the

an event

is

and

collateral

to

holders

test.
it

approximately
all

in the

orderly

debt

or equal

the portfolio

period

of the

often

of

to

words

other

20-issuer

tranche.

compared

In

the equity

might terminate

that

then

for

requires

debt

must be greater

to pass

control

the

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senior

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rated

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rate

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interest.

_________________________________________
Performing bank loans valued more than 90%

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accrued

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amount

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rates

asset categories

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loans

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of CDO assets is periodically

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Advance

PMorgan

Structure

Advance

multiplied

Handbook
15

834-5535

1-212

The market

CDO
Page

Inc.

Finance

Structured

months

all

passes

CDO
of

debt

its

its

tranches

OC

trigger

will liquidate
prescribed

are

itself

or

retired.

tests.

by the

life.

BARC0023972

New

York

May 29

2001

J.P

The
The
of

Finance

Structured

Lucas

Douglas

Inc

Securities

Morgan

Global

of debt

in

decline

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test

concern

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cure

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trade

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off

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because

diversity

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startling

uniformity

industry

sector

industry

Volatility

Indexes

Two

of

Week

Std

Dev

60

25

Double-A

67

26

Single-A

88

34

Triple-B

100

37

Double-B

277

93

Single-B

596

163

Triple-C

1547

447

JPMorgan

Table

Yield

and

In

of

Volatility

Constituent

USD

Yield

JPMorgan High

Index

Parts

vs
______________________________________________
Standard
Deviation
of Two Week Total
of Index

times

Total

Standard

of

Deviation

of Indexs

Returns

Source

202 bps

25

Two

Week

Industry

224 bps

Categories

JPMorgan

exhibited
across

asset

issuer

domicile

distribution

CDO

Typically

domicile
is

test

type

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length

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point

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problems

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of

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to

volatility

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period

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volatility

and

volatility

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rates

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enough

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intervals

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market value

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market value of

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valuation

or

period

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assets

wiPMorgan

are

the

there

where

scenario

so that

in

tranches

market value must

enough

quickly

Handbook
16

Market Value

of the

credit quality

OC

CDO
Page

834-5535

1-212

Effectiveness

its

Research

not
to

has

and

counted
have

restrictions

other
in the

latitude

be comfortable

with respect

collateral

to

OC

test

invest

attributes

to

concentrations

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in

with the allowable

wide
set

range

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is

usual

of assets

of assets and

by single

value in excess
for

The

name

industry

of concentration

market value asset

debt

their associated

tranche

investor

advance

rates

BARC0023973

New

York

May 29

2001

Securities

Morgan

J.P.

Global

Lucas

Douglas

Since

the

Research

Handbook
17

JPMorgan

834-5535

1-212

credit

CDO
Page

Inc.

Finance

Structured

of the market

quality

CDO

value

structure

depends

the

upon

actual

sale

become

arises over whether

sale can he
concern
necessary
the assets value.
This is referred
to as liquidity risk and its supposition

of assets should

it

completed

at

suggests

contradiction

cannot

sale

if

he

assets value

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at

completed

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bid-ask

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achieve

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sold.

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assumed

to

traded

bank

factor

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tenor

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prices

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factors

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or

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market value CDO.

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bonds and

even

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market

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market valuations an asset cannot

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with asset type

factors

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risk

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liquidity.

well-known

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ollateralization

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call

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on ownership can also make an asset

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liquid

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of market value

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time.

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felt

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do vary by asset type

spreads

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and the

tests

CDOs

liquidity
net

worth

risk
test

investor.

Table

Market

Value

Primary

Factors

Over-Collateral

Credit

izati

Factors

on

Test

Level

of advance

Cushion
and

Mark

to

Market

Volatility

Time

between

Cure

period

Interest

Credit

Rates
Source

of Tranche

and Net Worth

assets

and

tranche

par

tests

assets

credit

and

other

events

restrictions

familiarity

with

name and

Market

familiarity

with

asset

e.g.

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desperation

size

of

issuance

outstanding

type
constraints

diversification

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sell

Market

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of

volatility

for

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Interaction

value

quality

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haircut

volatility

spread

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OC
to

rate

Propensity

Risk

rates

between

accrued

Credit

Liquidity

Factors

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diversification

known and unknown

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of market

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and

size

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value

differences

movements
in

advance

factors
in

times

of

stress

rates

Test

JPMorgan.

BARC0023974

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York

May 29

2001

J.P

Finance

Structured

Lucas

Douglas

Research

ability

two

CDO

of the

factors

CDOs

that

the

affect

the

of cash flow debt

credit quality

withstand portfolio

to

and

assets

JPMOrgafl

Structure

above

discussed

briefly

Handbook
18

834-5535

1-212

Cash Flow Credit

As

CDO
Page

Inc

Securities

Morgan

Global

default

of cash flow debt

credit quality

of

the protectiveness

and

losses

tranches

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still

tranches

depends

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the

upon

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tranches

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riskiness

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Asset Risks
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respect

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to

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probability

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correlation

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severity

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and

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5%

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creditor

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CDO

total

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rating

probability

BARC0023975

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May 29

2001

J.P

Lucas

Douglas

and

Finance

Structured

default

Research

correlation

to credit

and

and

of the new

and

sheet

CDOs

the

Structural

bankruptcy

Priority in

debt

and

and

recoveries

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then

absolute

loss

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asset classes

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quality

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in

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discussed

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proceeds

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of the senior

next most

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below

in the section

on legal

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credit

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bond

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to tranches

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employs

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flow distributed

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flow

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cash flow

assets

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cash flows

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CDOs

CDO

at

credit risk

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assets in the

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in the targeted

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CDO assets will

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managers

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at

for sales

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from

tranche

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proceeds

calendar

can be

manager

selection

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to

issue

also

new

of recent

the credit quality

the

choosy

but

recoveries

They should

deterioration

robustness

seller

JPMOrgafl

should look

Investors

products

conditions

how

Handbook
19

834-5535

1-212

only for experienced defaults

related

CDO
Page

Inc

Securities

Morgan

Global

that
as the

effect
senior

to

susceptible

in

tranches

default

commensurately

Table

Typical

Sequential

Paydown

Structure
Initial

Tranche

Tranche

Equity
Total

Assets/Total

Source

few

Size

Structure

$MM

After

Subordination

Tranche

Collateral

$MM

Paydown
Subordination

$62

38%

$12

76%

$10

28%

$10

56%

$10

18%

$10

36%

$18

NA

$18

NA

$100

Liabilities

50%

Size

$50

JPMorgan

outstanding

payments

go

Some CDOs

The second
coverage

to

CDOs

senior

also

make

mechanism

tests

These

use

tranches
pro-rata

to

tests

fast

pay/slow

while

pay

smaller

distributions

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divert

cash

flows

structure

amount

goes

of principal

priority

in

where
to

to their

cash flows

from subordinate

the

bulk of principal

subordinated

tranches

tranches

is

the use

tranches

of collateral

prevent

BARC0023976

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York

May 29

2001

J.P.

Securities

Morgan

Global

Lucas

Douglas

In

form

simplified

market value

to par

asset

to

some

cause

counted

assets are

CDO

Note

In

test.

JPMOrgafl

senior

tranches

coupon.

the

test

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is

form

of

deterioration

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down.

to

main

test.

the

is

divert

ratio

style

of

assets are

CDO
excluded

determined by

as

cash

par.

lower of that

market value
test

from defaulted

used

two

coverage

the

at

asset credit quality

also

The

asset par to tranche

or

not

coverage

coupons

CDO

CDO
rate

par test

interest

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of

ratio

be paid

the interest

recovery

to

par
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such as credit ratings

measure

the

is

to

and

test

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at

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tranche

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test.

objective

and

assets

assumption or market value.

from the

Handbook
20

the over-collateralization

defaulted

interest

CDO
Page

are the over-collateralization

tests

coverage

In the test

CDO

new

in

Research

834-5535

1-212

reinvestment
collateral

Inc.

Finance

Structured

flows.

Chart

Over Collateralization
Tranclie

Collateral

Tests

Coverage

CDO

Test

Over-collateralization

Asset Par

Tranche

Tranche

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CDO

Test

Asset Par

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Over-collateralization

etc.

Par

and

Par

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Tranche

CDO

Where
credit

Source

Par

Asset
to

applied

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assets.

JPMorgan.

Chart
Interest Collateral
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etc.

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Test

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Coupon

and

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the

collateral

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over

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coupons
are calculated

non-defaulted

over

the

same

period.

JPMorgan.

typical

paydown

of payments

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Interest

proceeds

1.

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3.

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fees.

counterparty.

fcc.

tranche

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and

any termination

amount

counterparty

default.

BARC0023977

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2001

J.P

Finance

Structured

Lucas

Douglas

Inc

Securities

Morgan

Global

tranche

coverage
Interest

If the Class

tests

tranche

if

and

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tranche

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tranche

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of Class

the Class

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coverage

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reinvestment

only principal
flow cannot

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around

characteristics

such

have

rating

average

life

prospective

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Other concentration
participations

in

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assets

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sequence

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all

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until

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tests

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in

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case

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weighted

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down

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above

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tests

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due

fees

asset

13 Remainder

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coverage

or default

additional

12 Equity

met redemption of

repeated for each

are

amount

termination

11

are not

accrued

eight

Termination

10 Any

tests

necessary

interest

six

coverage

met

are

Class

Steps

JPMOrgafl

Class

on

and then

Handbook
21

met

are

tests

CDO
Page

834-5535

1-212

If the Class

Research

diversity

recovely
average

tests

address

triple-C credits

or

coupon

the

spread

presence

deferred

in

interest

the portfolio

instruments

of large
and

the

single

issuers

loan

like

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2001

Securities

Morgan

J.P.

Global

Lucas

Douglas

In

order

to

reinvest

thresholds
Since

at

and
is

portfolio

quality

and

concentration

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average

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quality

scrutinize

possible

allows

appreciation

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quality

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selling

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to

portfolio

gains

to

have

suffered

it

is

collateralization

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distribution

test

certain

the trade

and

their significance

as

whole.

actually

The purchaser of

concentration

value

CDOs

because

case

is

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improved

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rating

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also

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ask for

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cost.

and

tests

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sell

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skim off the

initial

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credit

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at

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be

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over

defaulted

permit the
But

restricted.

trading

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CDOs

as the

price

capital

satisfied.

which

asset

tests

otherwise

CDO

of the

same

coverage

would

of the

quality

by requiring

ratios are

only partial credit in the

trades

credit

credit quality

average

CDOs

most

might improve

this

the

over-collateralization

manager

coverage

decreased

presumably

causes

addressed

must be placed in the context

investor

matrix

average

cash flows.

available

eventually

subordinated tranches

subordination

tests

the

CDOs

interest

cash flow

assets against

in

asset

lower

at

par

of losers

now

is

Risk and Structural

Asset

each

these

among

coverage

by managers

an appreciated

deterioration

retention

performing

to

to

manager

circumstances

of proceeds

has

Balancing

for

CDOs

price

the

the

CDOs

in

are

satisfy

incorporate

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scenario

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widely

still

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now

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to

assets.

of winners and

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security.

the asset
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actual

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met

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to

that

price
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requirements.

tests

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purchase

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proceeds

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requirements

the

cause the portfolio

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is

portfolio

concentration

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concentration

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or

and

for acceptable

is

above

the portfolio

margin.

cash flow waterfall

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and

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independently.

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and

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quality

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often

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their thresholds.

quality

not

is

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the

maintain

also

measure

the portfolio

anyway

Handbook
22

the

proceeds

principal

and

if

or

Research

834-5535

1-212

above

described

CDO
Page

Inc.

Finance

Structured

scenarios

restrictions

trading

Protection
tranche

and

must

balance

the effectiveness

cash flows and

consider

how

control

the default

characteristics

of the coverage
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asset characteristics

quality

of

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might change

of trading.

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2001

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Global

Securities

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Douglas

Inc

Finance

Structured

1-212

Table

10

Cash

Flow Asset

Asset

Risk

Research

Handbook
23

JPMorgan

834-5535

Risks

and

Structural

Protections

Structural

Default

probability

Default

correlation

Cash

Default

loss

The

Protections

Subordination

flow
trigger

directing
Protection

Sources

CDO
Page

distribution
levels

cash

and

before

breech of coverage

effectiveness

of coverage

tests
tests

hire

flows

afforded

by

quality

and

concentration

tests

JPMorgan

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May 29

2001

J.P

Finance

Structured

Lucas

Douglas

CDO

receives

asset
the

of
In

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for

and

the

of the swap

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the protection

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the credit

on

premiums and

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protection

based

of the referenced

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CDO

the

obligor

where

definitions

CDO

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if

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swap

counterparty

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payment

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credit default

payment from
asset

this

asset

to insurance

exact

wiPMorgan

loans

or

into

by entering

periodic

return

bonds

purchasing

referenced

referenced

made

to

synthetically

default

Handbook
24

CDOs

alternative

obligor

Research

834-5535

1-212

Synthetic
As an

CDO
Page

Inc

Securities

Morgan

Global

of the referenced

to

the

suit

desires

The

definitions

asset

Chart 10
Credit

Default

Swap

Default

on Referenced

Losses

Event

Source

Asset

in the

Default

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JPMorgan

balance

synthetic

CDO

with the

example
offset

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the referenced

of credit or

letter

credit loss

assumes

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credit

buyer gets

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balance

are

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before

asset basis

losses

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default

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to

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per

portfolio

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banks

eases

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of view

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basis

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losses

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from loans because

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other

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have

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might be expressed on

protection

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amount

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sheet

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without

obligor

they

structured

being protected

are

in the

in

only

makes

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swaps

below

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or reluctance

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position

payment

capital

balance

in

can

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circumstances

borrower

required

amount over

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with

exposure

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swap

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to

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to the referenced

of credit risk to the referenced

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regulatory

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swap

exposure

or has

receivable

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protection

asset

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CDO the

sheet

owns

protection

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of

at

In

approval
all

of the

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or participation

in

as

loans

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BARC0023981

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May 29

2001

Securities

Morgan

J.P.

Global

Douglas

Lucas

Credit

default

advantages

the

separate

Handbook
25

PMorgan

of an asset from the assumption of

funding

credit derivative

use

shed risk while

to

maintaining

still

its

credit

funding

might have.

CDOs

Arbitrage

Synthetic
Credit

also

swaps
can

it

Research

834-5535

1-212

bank

risk.

CDO
Page

Inc.

Finance

Structured

default

CDOs

swap-backed

motivation for

synthetic

are

comes from

typically

CDOs.

with arbitrage

associated

increasingly

CDO

arbitrage

that

party

seeks

The

leveraged

of names.
It might be the case
that the CDO cannot
achieve
portfolio
exposure to
credit derivative.
To date almost all synthetic
exposure to the names other than through
CDOs have been based on static reference portfolios. In the future we anticipate active
credit

names

of underlying reference

trading

CDOs

will enter

number of

into

in

synthetic

individual

CDOs.

arbitrage

credit default

Synthetic

arbitrage

with different

swaps

counterparties.

CDOs

Funded and Unfunded

An

important

the

CDO.

find

other

Bistro

uses

cash

it

to

mature
under

defaulted

funded

was

swap

the

the

note

to

securities

purchase
as

from the security

to tranche

holders.

credit default

swap

shown

by

must therefore

credit

highly
in

Chart 11.

worthy

The

asset

If referenced
obligors
swap.
are used to pay the counterparty.

Another
in

cash investment

CDO

The method of JPMorgan

investors.

CDO

of the credit default

proceeds

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do not require

they

funded

for the

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that

buy

alternative

credit-linked

is

note

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create

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issuer.

11

Synthetic

CDO

with

Highly-Rated Asset

Pvet

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1998

credit

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to

from tranche

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by embedding

position

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where

for the

transactions

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of credit default

aspect
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asset
is

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of

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Default

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the

Glossary

entry

under

credit-linked

note

for

description

of an

alternate

method

of

investing

cash

proceeds

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2001

J.P

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Global

Douglas

In

Lucas

more

Research

synthetic

CDOs

simply enter into

In

tranche

CDO

Handbook

Page

26

wjpMorgan

834-5535

1-212

can

institution

Inc

Finance

recent

investor

take

Securities

Structured

chart

exposure

12

cash

investment

credit

investors

default

in the

to the referenced

has

become

swap with

the

optional

super senior mezzanine

portfolio

on

either

and

the

CDO

sponsoring financial
or equity

an unfunded

or

tranches

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funded

basis

Chart 12
Synthic

CDO

with Fundcd

and

Unfunded

Tranches

Portfolio
credit

swaps

Marketplace

Typically
Super

Unfunded

Senior

Investors
Single-name
credit

swaps

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or

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Unfunded
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tan
ItiiiiI

Onus A%A
sstIs

Source

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Equity

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Investor

JPMorgan

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2001

Securities

Morgan

J.P.

Global

Douglas

Lucas

The

its

of

manager

wider

appreciation.
to rely

tranche

CDOs
and

rules

small

prefer

manager

The argument

about

really matters

this

argument

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the

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to

underlying

is

some cases

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downside
other

CDOs

tranches.
the

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gains

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can be argued

arrangement.

manager

and

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audit

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as well.

expertise

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investor

and

as irrclevant

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that

stress

all

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performance.

normal portfolio

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and

policy

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because

to

of

ratings

the

is

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place

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on the

of credit for being able to improve

who

manager

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analysts

of credits in the same

analyst

debt

tranche

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capabilities.

Fitch

SP

reached

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purchases

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are satisfied that

investors

loss

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target

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and

firm

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nor debt
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is

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clout

of

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risk controls

risk-adjusted

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probability

with demonstrated work

compromise
the

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equity

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need

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of the managers

structural

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default

than the upside.

managers

analysis

rating

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intricacies

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credit assessment.

rating

take

management

of asset managers

CDO

in the

CDO

internal

and

appreciation.

on the CDO.

be focused

will

formal

is

experience

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hedging.

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prior to

restrictions.

trading

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agency

credits within

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to

may

manager

exchange

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managers

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and

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reviewing the asset manager.

back-up

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rate

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available

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that

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comply

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can avoid defaults

assets are not typically

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vehicle

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credit

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assets

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spurn discussion

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and

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time the credit manager

investors

be able

be to avoid defaults

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flow manager

instruments

large

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appreciation.

obvious that the market value

is

the

trading

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in derivative

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flow structure

cash

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in

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the

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and

and

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price

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manager

defaults

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often

is

to achieve

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of assets and

array

want

maturity.

flow manager

cash

price

Debt

JPMorgan

Manager

focus

that

Handbook
27

CDO

market value
with

Research

834-5535

1-212

Parties to
Asset

CDO
Page

Inc.

Finance

Structured

its

has

meaningful
fee

to

first

manager

The

debt

and

part

equity

loss position

will share

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of

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is

the

analogous

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to

owning

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on the

BARC0023984

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2001

J.P

Finance

Structured

Lucas

1-212

value of the

CDO

Douglas

CDO
of the

struck

portfolio

low

is

vega

But suppose

the

cash

along with potential

potential

change

chances

takes

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CDO
CDO

of asset manager

collateral

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Insurer

and

fail

tranches

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been

insurance

become

is

Rating agencies

insurance

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asset classes

bond

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hold internally

to

makes

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high

is

vega

do

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if

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the

want

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their

if

on

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that

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until investors

managers

tranches

capital to

in senior

and

tranches

guarantee

involvement

less

CDO

insure

of bond

of the

tranche

insurers

in

CDO than
CDO equity

insure

the perspective

the reduction

the

guarantee insurance

usually

unenhanced

hold

only

their

who

financial

structuring

insurer to

by

case

volatility

is

of payment

without

for

eroded

this

CDO

insurers

new

or

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trading

managers

sources

their bids

monitoring and

the

will require

insurance

in

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losses

should understand how

holders

the

double-A or higher

more generous

they would require

tranche

or

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bond

been

low and

is

restrict

insurance

two

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single-

appreciate

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bond

then have

used with new

and

familiar

transactions

insurer

rated

bond

incorporates

holders

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tests

for

yields but to have

craves

it

volatility

high and

is

virtue

for upside

their delta

outside

the

potential

money

and

of the

portfolio

most yieldy credit risky portfolio

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that

argue

businesses

and

already

of the

the potential

concentration

may

has

option

about

asset

relevant

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of options

and

also

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structure

bond

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motivation suggests

their other

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tranche

money

purchase

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quality

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language

deteriorates

to

bond

coverage

portfolio

CDOs

senior

it

the

In

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like

cant lose more than

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CDO

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equity

the

CDO

their delta

probabilities

losses prudence

at

is

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value

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ambivalent

are

higher

default

of equitys option

the value

in

appreciate

of the equity

value

intrinsic

such that equitys option

equity

would

holders

tranches

cash flow of the

after-default

put up with higher

to

of the debt

par value
the

is

money equity holders

flow
In the language

defaults

Unfettered

JPMOrgafl

in the

Equity

go

gains

the

at

CDO

cash flow

them they would have

potential

Handbook
28

834-5535

CDO equity is deep

CDOs after-default

When
their

Research

for

portfolio

CDO
Page

Inc

Securities

Morgan

Global

yield

with bond

than the bond insurer fee

greater

Co-Issuer

When

the

co-issuer
to

qualify

CDO
has
the

is

located

CDO

U.S

as

NAIC

Commissioners

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offshore

role in the

passive

corporate

guidelines

corporate

CDO

overall

structure

under

issuer

to

applicable

co-issuer
but

is

National

U.S

is

U.S

Association

insurance

used

often

sufficient

The

connection

of Insurance

companies

Rating Agencies

SP pioneered

market value

1990 however

Moodys

standards
diversity

that

more

Beginning

CDOs Moodys
1999

flexibly

respectively

and

in

ratings in

Fitch

came

became

1987

the rating

addressed

1996

SP

and

CDO

dominated

wider

began

out

more

range

rating the

with revised
active

and

cash flow ratings in 1988

of cash flow structures

of portfolio
second

due

credit

generation

quality

and

of market value

market value requirements

in that

By

to rating

in

1998

and

market

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2001

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Finance

Structured

Lucas

Douglas

Table

CDO

Handbook

Page

29

Inc

Securities

Morgan

Global

Research

JPMorgan

834-5535

1-212

11

Market

Rating Agency

By Number

Shares

of

SP

Moodys
1987

2000

2000

only

Source

CDOs

Rated

Fitch

66%

45%

30%

68%

46%

38%

JPMorgan

Swap Provider
CDOs

sometimes

enter

into

interest rate

flow of their assets to the requirements

rate

floating

CBO

CBO

The

cap

fixed

floating

on

coupons

The

used

if

Chart

13

CDO

Rate

Interest

Source

to

also

faces

the

provider

swap

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and

Trustee
Usually
servicing

payments

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in

counterparty

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currency swap

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example

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provisions

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payments

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payments

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makes
to

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tranche

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role

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holders

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collateral

quality

trustee

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coverage

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and Paying Agent

responsible

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the

to

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holders
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tranche

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quality

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rate

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rate

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liabilities

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or

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assets

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rate

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rate

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on

payments

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rate

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backed

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role

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and

to

and
typical

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difficult

portfolio

and
and

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trustee

cash

CDO

BARC0023986

New

York

May 29

2001

J.P

Morgan

Global

Securities

Douglas

Lucas

1-212

Underwriter
Usually
investors

Inc

Finance

Structured

Research

Wall Street

securities firm that

while satisQ4ng

the

managers produce
engage

other

relevant

balances

requirements

of legal

prospective

produce

JPMOiafl

and Placement Agent

the advice

and

Handbook
30

834-5535

reconciling

agencies

CDO
Page

tax

and

accounting

cash flow models

professionals

the

differing

of regulators

and

and

helpful

objectives

rating

The

experts
results

market the tranches

timely insightful

and

firm

negotiate

monitor

of tranche
and

agencies

may

advise

with rating

completed

transactions

research

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York

May 29

2001

Securities

Morgan

J.P.

Global

Lucas

Douglas

CDO

Handbook

Page

31

Inc.

Finance

Structured

Research

JPMOrgafl

834-5535

1-212

Legal Considerations6
Basic

Transaction

Arbitrage CDOs.

company
as described

CDOs

not

securities

transactions
the

transactions

investors under

of potential

Rule

501

CDO

The

issues

under

respect

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trustee

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asset

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to

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as

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in

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foreign

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on the date

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to

on

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assets

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placement

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investors

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to

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investors

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govern

transaction

securities

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equity

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will

the

trustee

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3c7

Section

persons in

include

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between

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representations

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expanded

by

and

33

the

although in some

of the 33 Act

will typically

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noteholders

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market transactions
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number of

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company

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pursuant to an indenture

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of the U.S.

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and

notes

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an investment

as

that

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Rule

of the 33 Act

qualified purchasers

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on

more

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securities

class

from registration

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sold

under

and

trust

form of subordinated

rcquircmcnts

in reliance

Investment Company
to

and

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qualified institutional buyers

offshore

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shares

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charitable

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in the

SPY

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Cayman

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or

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below

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is

and Documentation

Structures

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utilized

in many

cases

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liability

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company

analysis.

BARC0023988

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York

May 29

2001

J.P

Lucas

Douglas

owned
to

Finance

Structured

Research

by the sponsor or one

banks

insured

banks

also

loans

FASB

by

The

has

retaining

bare

participations

legal

from

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and

to

participations

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of fixed or floating

related

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and

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of

sponsor or one

pursuant

to the

its

recently

as sales

for

structures

by

any

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uses

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to

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obligors

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sponsor

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transfer

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issuance
in

swap

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default

participation
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to

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it

one

or

and

the

tranches
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secured

other

and

covenants

with

agreement

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act as servicer

to

sponsor agrees

in

provisions

and

representations

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certain

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purchase

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indenture

into

to

trust

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enters

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and

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purchase

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of payments

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pursuant

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provider

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business

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to

proceeds

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is

trust

priority

are offered

144A

Rule

SPY

of record

the

loans

securities

to

sponsor

sponsor as lender

to the

privity with the loan

for the benefit

mechanics

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CDOs

the

of positions

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loans

pursuant to an indenture

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agreement

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sponsor

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and

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rate

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to

in

structure

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participations

intermediate

certificates

trust

so that

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from

parties

sponsors

may

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that

continued utilization of one-tier

sponsor to the intermediate

equity
the

the trustee

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the

sub-participation

from

to

transaction

limit the

to the loans

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issues

of

to

interests or

participations

form

involving

transfers the loans

usually

with the loan obligors hut in most transactions

privity

title

made pursuant

the

SPY

CDOs however

issuing

would

assigned

ownership

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transactions

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intermediate
established

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banks

transfers

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sheet

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contractual

agreement

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of assets in one-tier structures

transfers

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loans

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JPMOiafl

The

affiliates

its

utilized

directly

accounting purposes
FDIC-insured

of

which

trust Balance

have

transfer

taken

CDO

sheet

business

statutory

Handbook
32

834-5535

1-212

balance

the

CDO
Page

Inc

Securities

Morgan

Global

U.S

to

persons that are qualified

non-U.S persons

or to

in offshore

institutional

transactions

buyers

in reliance

on Reg

Bankruptcy-Remoteness
If

bankruptcy

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to

realize

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U.S

CDOs
to

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full

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for

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In

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Bankruptcy

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U.S

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noteholders

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from proceeding

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of

with respect

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automatic

stay

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petition
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become

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than

as

true

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any non-bankruptcy
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because the transfer of assets by the transferor

purposes

were

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value of their collateral

proceedings commenced

assets

transferor

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experience delays

period

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interest

security
assets

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of the

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cause the noteholders

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to

sale of those

is

assets

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characterized
the

or

remote transferor

CDOs

as

and

of

the

transfer for

noteholders

BARC0023989

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York

May 29

2001

Securities

Morgan

J.P.

Global

Lucas

Douglas

he exposed

could

to

were

not

that

companies

FDIC-insured
has

To minimize
transaction

remote
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as

up

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or

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purpose
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notes

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parent

only

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to

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voluntary

board

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least

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member who

board

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number of impediments and

filing

established

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may

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to

agree

forth

set

in the

corresponding

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entity

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from the agencies

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form of requiring

voluntary

is

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purchasing

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to

business

transaction

of their ratings.

downgrade

of directors to approve

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confirmations

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merge

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against

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powers

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bankruptcy

liabilities.

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necessary

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the

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rise

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or unrelated

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in

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history

potential
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in the case

bank

in collateral

and

commencing bankruptcy proceedings

creditors

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entity

minimized

CDOs

universe

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into the

is

loss

in the U.S.

banks.

so that the

below

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to

ability

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limiting the

thereby

risk

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delays

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risk

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such

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to

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in

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relief

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own property

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state

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insured

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delays

payment

entities

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structured

entity

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companies.

value

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is

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banking

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bank

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creditors

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under the U.S.

relief

corporations

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for

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banks typically

to

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domiciled

are

banks

not include

payment

insolvency

Code

U.S. Bankruptcy

in

delays

eligible

an alternative

to

Handbook
33

or bankruptcy.

potential

insolvency

the transferor
subject

Research

834-5535

1-212

the transferors

CDO
Page

Inc.

Finance

Structured

petition

of the

independent

the interests

of the

with respect

to

SPYs

rated

all

and

SPVs

notes

in voting

petition.

disincentives

involuntary

filings

are

built

into

CDO transaction structure.

The transaction
structured
to impede
the ability
of holders
of the CDO
subordinated
securities to file involuntary
petitions against the CDO by
subordinated
securities to provide that amounts become
requiring the terms of the CDO
due in respect of such securities only to the extent that the CDO has sufficient funds to pay

the

is

such amounts
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petition

the

after

paying amounts

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into

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bankruptcy

until

or

in

respect

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year

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of

provider
all

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are required

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notes

to

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covenant

have

been

addition
not to
repaid.

BARC0023990

New

York

May 29

2001

J.P

Finance

Structured

Lucas

Douglas

CDO

or the

CDO

to

creditors

have

rendered

at

Isolation

From

Handbook
34

first

structured

is

in

interest

CDOs

the

other

any

an involuntary

file

noteholders

have

transaction

security

parents

Research

make

that

difficult

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transfers

made

in

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an asset that

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of payment

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nature

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to

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equity

petition

priority

holders
create

so that
assets

purposes

the

JPMOiafl

834-5535

1-212

Finally the
perfected

CDO
Page

Inc

Securities

Morgan

Global

and

sheet

Code
opinion

or
is

the

sale issues
to the loans

CDO

has

transactions

non-FD1C
delivered

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May 29

2001

J.P

Douglas

at

Lucas

provides

generally

FDIC-insured

consolidation

entities

priority

consolidate

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834-5535

1-212

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Page

Inc

Securities

Morgan

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May 29

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834-5535

1-212

and

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Finance

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Page

Inc

Securities

Morgan

Global

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New

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May 29

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834-5535

1-212

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Securities

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BARC0023994

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May 29

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Finance

Structured

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CDO

Handbook

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Inc

Securities

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New

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May 29

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Securities

Morgan

J.P.

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BARC0023996

New

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May 29

2001

J.P

Finance

Structured

Lucas

Douglas

Research

Considerations11

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Credit

Handbook
40

834-5535

1-212

Tax

CDO

CDO
Page

Inc

Securities

Morgan

Global

if

CDO

applicable

cases
or

offering

non-U.S

issues

Andrew

Chalnick

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BARC0023997

New

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2001

Securities

Morgan

J.P.

Global

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Handbook
41

interest

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authority.

be effective

CDO
Page

business

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changes

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Research

834-5535

1-212

the

Recently
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Inc.

Finance

Structured

tranche

as either ordinary

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BARC0023998

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2001

J.P

Finance

Structured

Lucas

Douglas

Inc

Securities

Morgan

Global

Research

CDO

Handbook

Page

42

JPMOrgafl

834-5535

1-212

Glossary and Notes

Advance

rate

as

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type

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quality

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See page

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entity

existing

See page

from

financial

28

flow with

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27

commercial

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allow

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2001

J.P

Finance

Structured

Douglas

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the

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The

supremacy
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JPMOrgafl

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Handbook
43

issues

1980s when high

late

CDO
Page

834-5535

1-212

purpose

In

Inc

Securities

Morgan

Global

physical

trust

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obligation

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24

derivative

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See page

credit

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30

divides

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21

payment

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May 29

2001

J.P

Finance

Structured

Douglas

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note

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Handbook
44

834-5535

1-212

Credit-linked

CDO
Page

Inc

Securities

Morgan

Global

of

transaction

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2001

J.P.

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Morgan

Global

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Handbook
45

834-5535

1-212

the asset portfolio

Equity

CDO
Page

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Finance

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2001

J.P

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Structured

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Research

amount

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Handbook
46

834-5535

1-212

Notional

CDO
Page

Inc

Securities

Morgan

Global

subordinated

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powers

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Handbook
47

19

See page

and

Research

834-5535

1-212

debt

CDO
Page

Inc

Securities

Morgan

Global

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Securities

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Handbook
48

834-5535

1-212

decades

CDO
Page

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of

definition

securitization.

which

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May 29

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J.P

Finance

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Rating

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www.fitchibca.com

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Rating Criteria for Cash

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Handbook
49

834-5535

1-212

Rating Agency

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CDO
Page

Inc

Securities

Morgan

Global

1997

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Januaiy 2001

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Inc.

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834-5535

1-212

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