Collateralized Debt Obligations: Structures and Analysis, Second Edition

CHAPTER 15

Structured Finance Credit Default Swaps and Synthetic CDOs

Until 2005, there was only a trickle of synthetic CDOs based on structured finance underlyings. Synthetic CDOs were almost always based on corporate credit. That changed in 2005 when Wall Street dealers released a series of templates for transacting single-name credit default swaps on structured finance underlyings (SF CDS). This jump-started the market for SF CDS, which in turn breathed life into the market for synthetic SF CDOs.

Not that documentation issues are settled. A group of end users, headed by monoline insurers, have proposed their own, very different, template for trades. This has lead to different varieties of SF CDS and synthetic SF CDOs. In this chapter, we look at SF CDS documentation issues and how they affect synthetic SF CDOs.

With respect to SF CDS documentation, we cover:

• The differences between corporate and structured finance credit.
• The evolution of SF CDS documentation.
• The competing dealer and end user templates.
• The SF CDS terms which best replicate the economics of owning a cash SF bond.

With respect to synthetic SF CDOs, we cover:

• Manager's new found flexibility in accessing credit risk.
• The creation of new SF CDO structures.
• The effect on SF CDO credit quality.

DIFFERENCES BETWEEN CORPORATE AND STRUCTURED FINANCE CREDIT

Two differences between corporate credit and structured finance credit drive the structure of their respective credit default swaps. Unfortunately, these differences ...