UBS has come out with what appears to be the first method of quantifying single-name risk in a portfolio of collateralized debt obligations, to determine just how diversified deals from different managers are. The tool comes as some collateral markets, for example the cash bond market, becomes increasingly homogenous with a handful of sub-prime mortgage lenders making up a disproportionate share of new bond sales.
Douglas Lucas, director in CDO research at UBS, noted collateralized loan obligations tend to be backed by a similar roster of obligors, even from different vintages. And on the structured finance bond side, originator risk has proven itself to be the most detrimental to investors in recent years. "The big screw-ups have been originator driven," he said, noting it thus makes sense to evaluate how correlated deals from different managers, but containing the same collateral, may be.
Lucas has developed a measure called excess OC Delta based on tracking the overcollateralization of a sample portfolio of seven CDOs. All deals, six of which are actual holdings of an investor whom Lucas declined to name, had exposure to Charter Communications, for example, yet its average concentration in any one vehicle is less than 2%. And even assuming Charter and the next seven-largest obligors defaulted and had 0% recovery rates (an unlikely scenario), Lucas found the excess OC would decline by an average of 40% in senior classes. Although that may sound like a large erosion, Lucas stressed that is an extreme example. "There is no generally accepted [threshold], but that makes me feel pretty comfortable," he said, referring to the 40.8%.