§ 01
| Product | Underlying Assets | Key Risk | Role in 2008 |
|---|---|---|---|
| CLOs | Leveraged loans (corporate) | Default rate on underlying loans | Performed relatively well |
| MBS | Residential mortgages | Prepayment + default risk | Central to the crisis |
| ABS | Auto loans, credit cards, student loans | Consumer credit quality | Secondary role in crisis |
§ 02
Tranching creates a waterfall: AAA tranches get paid first and absorb losses last. Equity tranches absorb losses first but earn the highest yield. The magic and danger of structured credit is that AAA-rated tranches can be created from pools of lower-quality loans.
§ 03
When reading about structured products, always ask: what’s in the pool? A CLO backed by B-rated leveraged loans is very different from an MBS backed by prime mortgages, even if both have AAA tranches.
§ 04
A CLO’s AAA tranche yields 150 bps over Treasuries while a corporate AAA bond yields 50 bps over. Why the difference?
§ 05
§ 06
Structured credit: an MBS (mortgage-backed security) has prepayment sensitivity. When rates fall rapidly, what happens to the MBS?
Five questions · AI feedback
Sit with the ideas.
A CLO has $500M in leveraged loans as collateral. The tranches are: $350M AAA (3% yield), $75M BBB (6% yield), $50M BB (9% yield), and $25M equity. If 5% of the underlying loans default with 50% recovery, which tranche absorbs the first loss?
Why: