Introduction to Securitization

MEASURES OF POOL QUALITY

From the viewpoint of both CDO investors and the rating agencies that are assessing and monitoring pool assets, the quality of the CDO pool is important. This is true for both balance sheet and arbitrage transactions as well as for both cash and synthetic forms. In the case of managed pools, the quality is important not just at inception but through the CDOs’ term, as the composition of the pool will change over time.

The checks on the pool are of two types: quality tests and diversity tests.

Asset Quality Tests

There are two asset quality tests: weighted average rating factor test and minimum and maximum weighted average coupon test.

Weighted Average Rating Factor

Since ratings are not numerical but alphabetical, rating agencies translate their ratings into numbers. These translated numericals are known as rating factors. The convention is that lower ratings are translated into a higher numerical. By weighting each asset in the portfolio by its rating factor and summing these products, a weighted average rating factor (WARF) is computed for the portfolio. The test involves monitoring the collateral so as to maintain a maximum WARF.

Minimum and Maximum Weighted Average Coupon

As the name of the test indicates, this test requires that the weighted average coupon (WAC) of the assets in the portfolio not fall below a specified minimum rate nor exceed a specified maximum rate. If a change in the composition of the assets allows the WAC to fall below ...