DB Jim Grant Email to HFs

7/24/2019 DB Jim Grant Email to HFs

1/10

From:

GREG

LIPPMANN

(DEUTSCHE

BANK

SECURI)

Sent:

Tuesday,

August 29,

2006

2:12

PM

To:

PAOLO.PELLEGRINI

;

NLOBACCARO

;'EKOSNIK

;

MARC

;

RICHARD

BARRERA

(GLENVIEW

CAPITAL

MAN)

;

PAOLO

PELLEGRINI

(PAULSON

&

CO.

INC.)

;

DAVID

MACKNIGHT

(MASON

CAPITAL

MANAGE)

;

ALAN

FOURNIER

(PENNANT

CAPITAL)

;

MICHAEL

PENDY

(DUQUESNE

CAPITAL

MAN)

;

NICK

LOBACCARO

(GEORGE

WEISS

ASSOCIA)

;

EDWARD

KOSNIK

(HUNTER

GLOBAL

INVEST)

;

JEREMY

COON

(PASSPORT

MANAGEMENT,)

;

JAMES

DIDDEN

(GSO

CAPITAL

PARTNERS)

;

GREGORY

PAPPAJOHN

(VARA

CAPITAL

LLC)

;

BRADLEY

WICKENS

(SPINNAKER

CAPITAL

LT )

;

MICHELLE

BORRE

(OPPENHEIMERFUNDS,

IN)

;

CEMIL

URGANCI

(ASHMORE

GROUP

LIMITE)

;

PAUL

TWITCHELL

(WHITEBOX

ADVISORS,

L)

;

SHAILESH

VASUNDHRA

(DEEPHAVEN

CAPITAL

MA)

; ANTHONY

BOZZA

(SAB

CAPITAL MANAGEME)

;

BRAD

ROSENBERG

(PAULSON

&CO.

INC.)

;

TYLER

DUNCAN

(WAYZATA

INVESTMENT

P)

;

STEVE

ROTH

(GLG

PARTNERS

LP)

;

DAVID

GERSZEWSKI

(AUTONOMY

CAPITAL

RES)

;

LEV

MIKHEEV

(MOORE

EUROPE

CAPITAL)

;

STEFAN

TSONEV

(UBS

LIMITED)

;

WYATT

WACHTEL

(YORK

CAPITAL

MANAGEM)

;

RENE

HO (MORGAN

(J.P.))

;

JOHN

GISBORNE

(TORONTO

DOMINION

BAN)

;

MATTHEW

J KEEGAN

(OSPRAIE

M ANAGEMENT

L) ;

PHILIP

GUTFLEISH

(ELM

RIDGE

VALUE

ADVI)

;

JEFF

MOSKOWITZ (MORGAN

STANLEY)

;

KENNETH

COE

(TALEK

INVESTMENTS

LL) ,

MATTHEW

BASS

(GSO

CAPITAL

PARTNERS)

;

ROPER

STRYPE

(RUBICON

FUND

MANAGEM)

,

ROBERT

NEMETH

(ELM RIDGE

VALUE

ADVI)

;

MARC

LEHMANN

(JANA

PARTNERS

LLC.)

;

JEREMY

SCHIFFMAN

(TPG-AXON

CAPITAL

MAN)

;

JORIS

HOEDEMAEKERS

(OASIS

CAPITAL

(UK)

L)

;

NEL JOSHI

(DEEPHAVEN

CAPITAL

MA)

;

DANIEL

DONOVAN

(GDG)

;

RAGHU

RAGHAVENDRA

(MOORE

EUROPE

CAPITAL)

;

CHAD

KLINGHOFFER

(GLENVIEW

CAPITAL

MAN)

;

JOSH ADAM

(GLG INC.)

;

JEREMY

SIMON (TPG-AXON

CAPITAL

MAN)

;

BRIAN VAHEY

(KING

STREET

CAPITAL)

;

DEAN

CARLSON

(SUSQUEHANNA

INVESTME)

;

JEAN

FAU

(DARBY

CAPITAL

IRELAN)

;

VARUN

GOSAIN

(CONSTELLATION

CAPITA)

;

MAULIN

SHAH

(POLYGON

INVESTMENT

P)

;

HARRY

MAMAYSKY

(OLD LANE,

LP)

Subject:

Fwd:

Two

Jim

Grant

articles

on

CDOs

Attach:

15664357.htm

Permanent

Subcommittee

on

Investigations

Wall

Street

The

inancial

Crisis

ential

Treatment

Requested

by

DBSI

Report

Footnote

#963DBSI_PS_EMAIL0

6

onfi

Footnote Exhibits - Page 0509


2/10

Message Sent:

08/29/2006 09:12:02

From:

GREGLIP@BBOTGIGREG

LIPPMANNIDEUTSCHE

BANK

SECURIl]7261328663

To:

[email protected]

I

To:

[email protected]

II

To:

[email protected]

I

To:

MARC@JANAPARTNERS COMMARC|I

I

To:

RBARRERA2@BBOTGIRICHARD

BARRERAIGLEN

VIEW

CAPITAL

MANI I

To:

PPELLEGRINI3@BBOTGIPAOLO

PELLEGRINIIPAULSON

&CO.

INC.| I

To:

DMACKNIGHT@BBOTGIDAVID

MACKNIGHTIMASON

CAPITAL MANAGE

I

To:

AFOURNIER@BBOTGIALAN

FOURNIERIPENNANT

CAPITAL

I

To: GMPENDY@BBOTG MICHAEL

PENDYIDUQUESNE

CAPITAL

MAN|

I

To:

NLOBA@BBOTGINICK

LOBACCAROIGEORGE

WEISS ASSOCIAI

To:

EKOSNTK@BBOTGIEDWARD

KOSNIKIHUNTER

GLOBAL

INVEST|

I

To:

JMCPASSPORT@BBOTGIJEREMY

COONIPASSPORT

MANAGEMENT,|

I

To:

JDIDDEN2@BBOTGIJAMES

DIDDENIGSO

CAPITAL PARTNERSI

I

To:

GPAPPAJOHN4@BBOTGIGREGORY

PAPPAJOHNIVARA

CAPITAL

LLCI

I

To:

BWICKENSI@BBOTGIBRADLEY

WICKENSISPINNAKER

CAPITAL

LTI I

To:

MBORRE

I@BBOTG|MICHELLE

BORRE|OPPENHEIMERFUNDS,

N|

I

To:

CURGANCII@BBOTGICEML

URGANCIIASHMORE

GROUP

LIMITE

I

To: PTWITCH@)BBOTGIPAUL

TWITCHELL WHITEBOX

ADVISORS,

LI I

To: SVASUND@BBOTGISHAILESH

VASUNDHRAIDEEPHAVEN

CAPITAL MAI

I

To:

ABOZZA@BBOTGIANTHONY

BOZZAISAB

CAPITAL

MANAGEMEI

I

To:

BSROSENBERG@BBOTG BRAD

ROSENBERG

PAUL

SON

&

CO.

INC.1

I

To: TJDUNCAN@BBOTGITYLER

DUNCAN|WA

YZATA

INVESTMENT

PI

|

To:

WOODY2@BBOTGISTEVE

ROTHIGLG

PARTNERS

LPI I

To:

DAVIDG@BBOTGIDAVID

GERSZEWSKIIAU

TONOMY

CAPITAL

RES|

I

To:

LVMIKHEEV@BBOTGILEV

MIKHEEVIMOORE

EUROPE

CAPITALI

I

To: TSONEVS@BBOTGISTEFAN

TSONEVIUBS

LIMITED|

|

To:

WJWACHTEL@BBOTGIWYATT

WACHTEL|YORK

CAPITAL

MANAGEMII

To:

RENEHO@BBOTG|RENE

HOIMORGAN

(JP.)

To:

JGISBORNE@BBOTG|JOHN

GISBORNEITORONTO

DOMINION

BAN

To:

MAKEEGAN@BBOTG|MATTHEW

J KEEGANIOSPRAIE

MANAGEMENT

LI

I

To:

PGUTFLEISH2@BBOTG|PHILIP

GUTFLEISHIELM

RIDGE

VALUE

ADVII

I

To: JMOSK@BBOTGlJEFF

MOSKOWITZIMORGAN.STANLEY

To:

KCOE1@BBOTGIKENNETH

COEITALEK

INVESTMENTS

LLI

I

To: MBASSI@BBOTGIMATTHEW

BASSIGSO

CAPITAL

PARTNERS

I

To: RSTRYPEI@BBOTG|ROPER

STRYPEIRUBICON

FUND

MANAGEMI

I

To:

RNEMETHI@BBOTGIROBERT NEMETHIELM RIDGE

VALUE

ADVII

I

To:

MARCLEHMANN@BBOTGIMARC

LEHMANNIJANA

PARTNERS

T.IC.1I

To:

JSCHIFFMAN@BBOTGJEREMY

SCHIFFMANITPG-AXON

CAPITAL MAN

To:

JORISI@BBOTGIJORIS

HOEDEMAEKERSIOASIS

CAPITAL

(UK)

LI

To: NJOSHI@BBOTGINEIL

JOSHIIDEEPHAVEN

CAPITAL

MA

To: DDONOVAN5@BBOTGDANIEL

DONOVANIGDGI

To:

RAGHAVENDRA@BBOTGIRAGHU

RAGHAVENDRAIMOORE

EUROPE

CAPITALI

To: CKLINGH1IOFFER@BBOTGICHAD

KLINGHOFFERIGLENVIEW

CAPITAL

MAN

To: JOSHADAM@BBOTG|JOSH

ADAMIGLG

INC.

I

To:

JSIMONTPG@BBOTGIJEREMY

SIMONITPG-AXON

CAPITAL

MAN

To:

BVAHEY@BBOTGIBRIAN

VAHEYIKING

STREET

CAPITAL

To:

DCARL@BBOTGIDEAN

CARLSONISUSQUEI

HANNA

INVESTME|

|

To:

JFAU@BBOTGJEAN

FAU|DARBY

CAPITAL

IRELAN|

|

To: VGOSAINI@BBOTGIVARUN

GOSAINICONSTELLATION

CAPITA

To: MAULIN

SHAH@BBOTGIMAULIN

SHAH|POLYGON

INVESTMENT

P| I

To:

H.MAMAYSKY@BBOTG|HARRY

MAMAYSKY|OLD

LANE.

LP

Original Message-

From:

Greg

Lippmann

At:

8/28

17:32:17

Treatment

Requested by DBSI

DBSI

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EMAIL0 162



3/10

Structured Complacency

Credit markets

are

sanguine.

Structured

credit

is

proliferating.

Could

the

first fact

be related

to

the

second?

Yes,

we say.

There?s

no end

of explanation

for the

mysterious

willingness

of

bond

buyers and

bank-loan

investors

to accept

persistently

modest

returns

over

riskless

government

yields.

Liquidity

has

been

superabundant,

hedge-fund

assets are on

the

prowl, yield

thirst goes

unslaked?all

these causes

are put

forward.

We

are

about to

suggest

another

explanation

for the

bewildering

complacency

of

lenders.

Spreads

are

tight

in

part because

of

the

growing number

of

collateralized

debt

obligations

(CDOs).

What

these entities

share is

a strong

propensity

to

buy and

a

low

propensity

to sell.

A

new fact

commands

the attention of

lenders

and

borrowers:

Financial

engineering

is displacing

credit

analysis.

Definitions

are in order.

A

CDO

is

a debt-acquisition

enterprise.

It

raises money from

investors.

It

acquires assets with

the proceeds?bonds,

bank

loans,

mortgages,

asset-backed

securitics,

etc.

It can buy

floating-rate assets

or

fixed-,

senior

claims

or subordinated.

In 2005,

no

less

than

$250

billion

of

CDOs came into the

world, 59%

more than

in

analysis,

we

venture

the following

capsule

distinction:

financial

engineering

is the

science

of structuring

cash

flows; credit

analysis

is

the

art

of getting paid.

The

liabilities

side of

a CDO

balance

sheet

is what

gives

the

structure

its

distinctive

investment

personality.

The

liabilities

are

layered.

Field-strip

a

typical

$100

million

CDO and

you find,

first,

a

large

swath

of

?senior?

liabilities,

say

$70 million

worth,

rated

triple-A;

a $20

million

?junior?

slice

rated

single-

or

double-A;

a 3

million

mezzanine

piece

rated

triple-B;

and

7 million

of

unrated

equity.

The top-rated

assets

are

not

inherently

triple-A.

Their

strength

derives

rather

from the

vulnerability

of

the

assets

underneath.

The

equity

tranche

is

most

exposed; to it

goes

the

first

loss. When

it

has borne

all

it

can bear

(i.e.,

7 million),

the

next

loss goes to

the

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mezzanine tranche and the

next to the junior

slice.

Only

after all of

these levees are

breached--$30

million

worthdo

losses cut

into the value

of the senior segment.

The

various segments are

priced according

to their risk,

with

the senior-most

yielding

a

few

dozen

basis

points

over

Libor and

the

equity

segment returning

1,000

basis points

over (or

more). The

cost

to

create

such a structure

runs to about 1.5%

of

the

balance-sheet

footings.

Included

are legal,

rating and

origination expenses.

Annual

management

fees may

run to 50

basis points.

Although

some

CDOs are

?static??the

assets with

which they

are seeded

are the

ones

they

keep?some

latitude

for

the managers is

increasingly the

norm.

Our

?typical? CDO

is known

as a ?cash?

CDO It

is not to he

confused

with a ?synthetic? CDO.

Like the

cash variety,

a synthetic

CDO

raises

money from

investors. Then

it sells

credit protection

to

other

investors,

in the shape

of credit

default

swaps

(CDS). The

cash CDO

eams

income from

the securities

it holds.

The synthetic

CDO

eairns income-from

the premium

it writes.

In

a

few

short years,

these

derivative structures

have

marginalized

the

vast corporate

bond market.

Companies

still

issue public

debt, but

Wall Street

is

trading less

and less

of

it. The charm

of

the

old corporate

arena?with its

generously

separated bids

and

offers and

its

personable,

richly

compensated

sales

peopleproved its

undoing. Th e

advent of

price

transparency

through the

TRACE

reporting system

hathed the

marketplace

in sunlight.

Blinking,

the

salespeople

watched

quotations

tighten and

commission

income dwindle.

?Banks

that trade

corporate

bonds

have been

required

to report

transactions

to TRACE

since

2002,?

Bloomberg

noted

in a May

9

report

on

the historic

shift

from

cash transactions

to derivative

ones

(?Derivatives

Make

Nich Carraway,

Corporate

Bond

Traders Obsolete,?

is

the

headline).

?The

system now provides

prices and the

amount

of

bonds

exchanged

in

each

trade on

29,000

securities with

in 15 minutes

of a deal,

according

to

NASD.

With

the data

available,

there?s

little

need

for guidance

from

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analysts

or

salespeople.?

Observe,

please, the

analytical

leap

implied in

the

final

three

words

of

the

quotation: ?analvsts

or salespeople.?

Why should

price

transparency

make

analysts obsolete?

Hypothesis

No.

1:

Because, in an

efficient

market,

a security?s

price

is

the unfailing

measure of

its

value.

Hypothesis No. 2: Because,

on

Wall Street, the

analysts are

paid

out

of the

big fat commission

pot.

We

lean

toward No.

2.

Credit risk is

ever present.

Where it

resides is

the timely

question.

Once

upon a

time, before

?disintermediation,?

the

risk

of

default

or nonpayment

lay with

the

banks.

It was the

banks? business

to

know more

about

their borrowers

than

anyone else.

Come the

junk-bond

revolution, the

risk

migrated out

of

the

banks and into the

securities

markets. Now

comes

the

derivatives

boom.

Who

are

the keepers

of

the

flame

of

credit analysis in

2006?

We?re

not sure?and

neither is

the International

Monetary

Fund.

?[R]ating agencies

have

played

a significant

role in

the

acceptance of

new

products

by investors,

with the analysis

and rating

of structured

products

heavily reliant

on

sophisticated

quantitative

modeling,? says

IMF?s

2006 Global

Financial

Stability

Report (see

Chapter

2, ?The

Influence

of

Credit

Derivative

and

Structured

Credit

Markets on

Financial

Stability?).

?Not

surprisingly.

The

development

of

structured

credit

markets

has coincided

with

the increasing

involvement

of people

with

advanced

financial

engineering

skills required

to

measure and

manage these

often

complex risks. In

fact,

for

many

market

participants,

the

application of such

skills may

have become

more

important than

fundamental

credit

analysis.?

This provocative

thought is

developed

in a one-sentence

footnote, as

follows: ?Discussions

with

market participants

raised

questions as to

whether the

increased

focus on

?structuring?

skills,

relative

to

?credit?

analysis,

may itself

present

a

concern.?

Emphatically,

the

rating agencies

are on

the

job. Since

a CD O

without a triple-A-rated

senior

tranche

would

be

unmarketablc,

their

imprimatur is

indispensable.

For

Moody?s Corp.,

the

sole publicly

traded

rating business,

derivatives

are the

wave

of

the

futurc?and

of the

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present,

besides. In the

first

quarter,

structured finance

generated

revenues

of $176

million,

nearly

double the contribution

of

oldOline

corporate debt

ratings.

Colleague Ian

McCulley

was

unable to

elicit from any

agency

just

what this

booming

business

entails.

But

he did catch

up

with ajunior

analyst

at one

ratings

shop,

who

described

his work

in monitoring

as

many

as

20

CDOs

a day. Both

the analyst?s

name and his

employer?s

are being

withheld

to

protect

the innocent.)

?Basically,?

says our

source,

?I

go

through

what they

buy and

sell

each

month.

And

I

go

through

all of their

ratios.

And

I check

to

see if

they

have synthetics,?

e.g.,

credit

default

swaps.

It?s all in

an Excel

model.

The

CDOs he checks

are actively

managed.

Interestingly,

some of

them

invest in

the

tranches

of other

CDOs, and

they

are

called

?CDO squared.?

It?s

no easy

matter

to rate

these

exotica,

even

with

the

help of

a complex

model

developed

for the

purpose

by

Moodys.

Our

admittedly green

contact

says

he

doubts that

many

people

really

understand

what these

structures

own, how

their

assets

are

correlated

or

what might

happen

to

them

in

the

liquidation

portion

of

a

credit

cycle.

A skeptical

friend of

ours

applauds

the bank-loan-holding

CDOs. Michael Lewitt, president of

Harch Capital Management,

Boca Raton,

Fla.,

is the

manager

of 150

bank

loans

(which

constitute

a collateralized

loan

obligation,

or

CLO,

a

species

of

CDO).

He

contends

that

the loan

structures

do

work?and

Lewitt, in his

professional

capacity,

is

a hard

man

to please.

Yes,

he

readily

acknowledges,

credit

spreads are

too

tight,

but ?even if

a

loan

defaults,

you

still

get

recoveries

of

95 cents

on the

dollar,

or even

over par, so

you are OK.?

Lewitt is

here

referring

to

senior

loans. Beware,

he says, the second-lien

kind,

which are

really

?just

bonds,

and

that?s

where you

will

have some

real capital

impairment.?

Our

investigation

leads

usto the

same

conclusion,

though

most

lenders

and

borrowers

are

wondering

less

about

capital

impairment

than

about

what took

them so

long to see

the

beauty

of

junior

bank claims.

Among

these

merits is

the

east of

early

call

(at the

borrower?s

behest

and

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7/10

with fewer

of the costs

and

restrictions

typically

associated

with

calling

a corporate

bond) and

the fact

that they

pay

a floating, not

a

fixed,

rate

of interest. Their issuance

is

soaring. According

to Steven Miller,

manageing

director

of S&P?s

Leveraged

Commentary

and

Data

Group,

16

billion

of second-lien

paper

came to

market in

2005. 35%more than

in

2004.

And while junk-bond

issuance

last

year totaled

$75 billion,

less

will

be

sold

this year.

?Furthermore,?

colleague

McCulley

observes,

?second liens

are tailor-made

for

the current

state of

the

financial

world,

hedge

funds

.

absorb 37% and CLOs 48%

of second lien issuance nowadays.

Libbey Inc.,

the

Toledo, Ohio,

glassmaker

profiled

in

the

April 21 issue

of

Grant?s,

is

among

the companies

that

has

recently

forsaken the junk

market for the

second-lien

market,

it

expects to tap

it any

day.?

What?s

there to be afraid

of?

a

practitioner

we know

rhetorically

asks: ?For

a deal

that has

locked in

its liability

costs for

in

the market

that would

bring

back

credit spreads

to

more

natural

levels.?

Be careful

what

you wish

for, we

say. The

financial engineers

are

up in

the

driver?s

seat

of credit,

a fact

that

ought to

worry

everyone

except

distressed

investors.

?[Flor

some

mezzanine

structured

credit

products,?

the aforementioned

IMF

paper

speculates,

?zero

recovery

rates

are

much

more

likely

than

on similarly

rated

corporate

bonds. yet

the

resulting

default probabilities

and

expected

losses

are mapped

into

traditional

corporate

bond ratings

that

tend to

be

in

the

40%-60%

range.?

No

default

epidemic

is

imminent,

our friend

Lewitt

asserts.

Yet,

he points

out,

something

is bound to

interrupt

the

present idyll.

Something

?systemic? is

his

nomination.

?These

hedge funds

are

not

a

sign

of health and

this

equity day

trading is not

a

sign

of health.

And

having

a

credit

market priced

on

a non-credit

basis?meaning

priced off

quantitative

and

arbitrage

bases and

not on credit

fundamentalsis

not

a

healthy

thing.?

Credit

markets

ought

to be

priced on

the

basis

of

eredit,

of

course?and,

one day,

most

assuredly,

they

will

be again.

Treatment Requested

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DBSI-PSI-EMAIL01625



8/10

English

Majors? Revenge

Collateralized

debt obligations

are only

baffling

most of the

time.

Gibberish, the

technical

literature may

be,

but a

determined reader

can make

out the

occasional familiar

English

word or

phrase. One such

word

is

?assumption.? It turns

out to be of

critical

importance

to

understanding

how

these complex

structures

are

designed, priced

and sold.

Now

begins

another voyage of

discovery.

The

destination: Th e

land of

the CDOs.

The

missions:

Understanding.

W e

write on behalf

of

all

who

stand suspicious

but

mute before the

mathematical

guardians of

this 1

trillion market.

Do

you, Mr.

or Ms. Former

English

Major,

suspect that

there is

a fly in the

derivatives

ointment but are

afraid

to

express a

doubt

in

the company

of

quants? We

are

going to

arm

you

with

the

facts.

By

way of

background,

the

housing market is only

as

strong as

the mortgage

market.

And the

mortgage

market,

these days,

is

only

as

strong

as the

CDOs into

which are

packed

hundreds of billions

of

dollars

of housing-related

debt

prime

and subprime,

?cap corridor

bonds,?

Alt-A-pass-through

hybrids

and others you

may not

want

to

ask

about

just

now). And the

CDOs

are

only

as

viable as their

equity

base.

In

previous

issues, Grant?s has

described

these

securities and

the

risks that

unsuspecting

investors

may run

in holding

them.

This time

out, the

focus

is on

the junior-most

portion

of the

CDO

liability

structure, i.e.,

the equity

tranche.

It?s

the equity

that bears the

first

loss

or,

if

all goes

according

to plan,

eams

the highest

return. You

can?t sell

a CDO

without

some

sliver

of

equity?and

sliver

is the

word.

High-grade

deals are

leveraged

at 100:1 on up.

Buyers of

this

derivatives

dynamite are

said

to include hedge funds

as well as

institutions

in

Japan,

South

Korea

and Southeast

Asia.

In

March, Moody?s

performed

the

signal public

service

of

compiling

actual

returns

on

equity portions of 66 ?terminated? CDOs (i-e.,

entities

that,

for one

reason

or another,

had

reached

the end

of their

useful lives).

It

found that returns

ranged

from

a negative

82% to

a

positive

99% and

that

the median

return

was very close

to

zero.

The

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9/10

Moody?s

analysts

were

not dogmatic,

however,

because

they

could

not

be

sure

what

investors

had paid for

the

securities

they

were examining:

?Unfortunately,

the pricingof

equity is

the

result

of

a highly

private,

sometimes

complex

negotiation.?

In a

follow-up

study of

the equity

tranches

of 10

terminated

structured-finance

CDOs,

Moody?s

last

month

found

that returns had ranged from

a

negative

59. 1% o a positive

70. 1%,

with the

average at

a negative 8.4%.

A

curious

layman will

now

begin to

appreciate the

significance

of

the

word

?assumptions?

in the context

of

expected

CDO returns

(especially

when pricing

is as

transparent

as

a curtain of

lead).

With

enough of the

right

kind of assumptions,

the equity

-tranche

buyer

can

sleep the

sleep of

the confidently

misinformed.

But such

self-delusion

will be

a

little

harder

to achieve since

publication

of a July

26

report by

Deutsche

Bank

entitled, ?High

Grade ABS

CDOs? (in

which

ABS

stands for

?asset-backed

securities?).

The

analysis

calls

into

question

the premises

on

which

such

derivatives are

built and

sold.

?Modeling

assumptions

that simplify

actual

cash flows are

commonplace

in

the

world of

structured

finance,? the

authors note.

?However,

while these

adjustments

are

unlikely

to

significantly

impact

the

debt,

they can

have significant

consequences

on equity returns?especially

within a

structure

that

is leveraged

100

to 200

times.?

And

what

might

these

dubious

assumptions

be?

Asset

and

liability

cash-flow

mismatch, is

one. Something

having to do

with

a five-

to

seven-day

?trustee period?

at the

time

of issuance is

another, and

?risk mismatch

in

2004 CDOs?

is

a third. A

fourth

involves

the

universal

impulse

to

reach

for yield: ?In

the

current

relatively tight spread

environment,?

the

report

says, ?collateral

managers

have

increasingly

turned

to

higher

yielding

alternative prime

mortgage

products to add

additional

yield to

the CDO

portfolio.?

These

are,

or have

been, the

best

of times for

housing,

the

Deutsche Bank authors observe.

Drawing

comfort from past performance,

investors

have

come to

regard

?the

structures and

the

various

modeling

assumptions

that are

embedded

within them?

with

unwarranted

confidence.

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DBSIPSIEMAIL 1625



10/10

Especially is

confidence

unwarranted

at

a time of elevated

leverage.

?I

don?t

want to suggest

that anything

malicious

and

underhanded

is going on

here,?

Anthony Thompson,

managing

director and

head of U.S. asset-backed

security

and

CDO

research for Deutsche

Bank,

tells colleague

Dan

Gertner.

?I

think the

reality

is

that

a

lot

of the

CDO

architecture

and

technology

was

created 10 to

15 years ago

when

spreads

were wider,

leverage

was lower

and where

you

didn?t

have

to be

so

meticulous

with

your assumptions.?

Buyers

of

these

equity

pieces

are

no t

necessarily

the

world?s

most sophisticated

modelers

of

structured

finance

securities,

Thompson

adds. ?1

would

make

the

point that

mortgages are

complicated

still

to

most

of the world.

Mortgages

levered 200

times

are

even

more complicated.?

By

tweaking

some

standard

assumptions

to make them

conform

with the 2006

marketplace,

the

Deutsche

Bank study

adjusts

an ?idealized?

expected return

of 19% to a

more realistic

10.2%

return. Note

well,

however, as the

authors add,

that

CDOs are

built

on

many

assumptions

They

acknowledge

that

they

examined

?but a few

pieces

of the

complex

CDO

puzzle.?

Come the

next bear

market in

mortgage

debt,

many

more

assumptions will

certainly

come in

for reappraisal.

Knowing only

this

much,

the

detached and

calculating

English

major

might

well

be able

to

sweep up

astonishing

bargains.

This

e-mail may

contain

confidential

and/or privileged

information.

If you are

not the intended

recipient

(or

have

received this e-mail in error)

please

notify

the

sender

immediately

and

destroy

this

e-mail.

Any

unauthorized

copying,

disclosure

or

distribution

of

the

material

in

this e-mail

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