101 Concepts for the Level I Exam
Essential Concept 72: Credit Analysis of Securitized Debt
Credit analysis of structured debt requires a different approach compared to credit analysis of other risky bonds. There are three major factors to consider when evaluating asset-backed securities (ABS):
- Underlying collateral –
- Granularity and homogeneity describe the underlying collateral. Granularity refers to the number of obligations in the overall structured financial instrument. Homogeneity refers to the degree to which the underlying debt characteristics within a structured financial instrument are similar across individual obligations.
- Three major credit analysis approaches can be used for ABS: book of loans, portfolio, loan by loan. The appropriate approach depends on the asset type, tenor and granularity/homogeneity of the underlying.
- Origination and servicing of collateral – Two major questions asked here are:
- How good is the servicer at managing and servicing the portfolio over the life of the transaction?
- What is the track record of the servicer?
- Structure of the transaction – Two major questions asked here are:
- What is the relationship between the issuer (SPE) and the originator?
- What credit enhancements are in place?
Covered bonds: Covered bonds are senior debt obligations issued by a financial institution. The unique feature of covered bonds is that they give recourse to the originator/issuer in addition to the predetermined underlying collateral.
When evaluating covered bonds, we should consider both the dual recourse principle as well as the quality of the underlying asset pool.