The Handbook of Municipal Bonds

CHAPTER 41

Municipal Collateralized Debt Obligations

Rebecca Manning Vice President, Structuring Harbor Asset Management

 

Douglas J. Lucas Executive Director and Head of CDO Research UBS

 

Laurie S. Goodman, Ph.D. Cohead of Global Fixed Income Research and Manager of U.S. Securitized Products Research UBS

 

Frank J. Fabozzi, Ph.D., CFA Professor in the Practice of Finance School of Management Yale University

 

 

 

Given their strong credit profile and historical performance, municipal bonds (munis) would seem ideal collateralized debt obligation (CDO) collateral. But munis have only made a couple appearances in CDOs because traditional CDOs cannot pass the tax-exempt interest of munis on to CDO investors. And the cost of a before-tax coupon to CDO debt holders leaves little “arb” for CDO equity investors. However, in September 2006, the first 100% cash muni CDO hit the market: Non-Profit Preferred Trust I (NPPT).

We also thank David Gilliand, CFA and Vaibhav Kumar, of UBS municipal bond trading and CDO structuring, respectively, for providing us with their expertise.

By using a structure that differed slightly from that of a traditional CDO, and focusing on a niche within the muni market, NPPT paved the way for future tax-exempt muni CDOs.

In this chapter, we discuss muni CDOs. Muni CDOs are likely to focus on issues in three sectors: nonprofit corporations, limited recourse housing, and enterprise financing. Nonprofit corporations are tax-exempt entities according to Section 501(c)(3) ...