CPDOs suffer more downgrades

Rating agency Standard & Poor's (S&P) has downgraded 28 of the 29 constant proportion debt obligation (CPDO) transactions it rates.

Of the 28 downgraded, 26 were stripped of their AAA rating. Two others were removed from the AA list. The instruments are now rated as follows: two AA, two A+, three A, one A-, 10 BBB+ and 10 BBB. Only one remained at AAA, albeit on negative creditwatch. Two formerly AAA CPDOs, now AA rated, are also on negative creditwatch.

CPDOs are structured products that sell protection on the main US and European indexes of credit default swaps (CDSs). CDSs provide insurance against non-payment of corporate debt. With up to 15 times leverage, CPDOs have historically had top credit ratings (AAA or equivalent), while paying investors higher returns than a traditional AAA rated bond.

The vicious tides that have hit the credit markets have caused high volatility, widening spreads and a reduction in the net asset value of these instruments. Spreads on the Globex index, a combination of the CDX and iTraxx indexes used as a benchmark for CPDOs, reached a peak of 153 basis points on February 13, 2008. This has put pressure on rating agencies to revisit the fundamentals of the way they rate these instruments.

As a part of its revised modelling, S&P has introduced a multi-period rating transition framework, which models the ratings on the assets in the underlying portfolio. Spread modelling has also been revised, applying more emphasis on the spread levels of each underlying asset.

S&P, which has rated about $2.4 billion worth of CPDOs, said: “For most CPDO transactions, there is an increased risk that net asset values may not be able to build value sufficiently for the structures to cash in."

On December 20, S&P placed all 29 of its publicly rated CPDO deals on watch for possible downgrade. On the same day, Moody’s Investors Service put 11 corporate CPDOs on review, and later downgraded 10 of these on January 9.

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