Pricing Portfolio Credit Products

Abstract

Portfolio credit products have a long history in the financial markets, stretching back to the German (Prussian) Pfandbrief (Covered Bond) with its origins in the late 1700s’ reconstruction following the Seven Years War. There are many names for and structural features of portfolio credit instruments but they all share the common feature of having a claim secured on a portfolio of single credit instruments (typically loans, bonds, credit derivatives, etc.) with additional structural features to enhance the credit quality. While portfolio credit products in general have a long and successful history as financial instruments, many having performed well even throughout the credit crisis of 2007–2009, it is also true to say that some areas of the securitization market, in particular subprime RMBS and much of the synthetic securitization market, were the proximate cause of the financial crisis. In these cases the poor quality of the underlying assets (subprime mortgages) together with the leverage enhancing effect of synthetic structures created widespread and largely unforeseen losses on assets that were highly rated by the Rating Agencies which precipitated the global financial markets into the credit crisis. The accompanying freezing of the interbank market required large scale government interventions to prevent an even worse crisis than ultimately transpired.