Capital Markets

Sifting Through the CDO Wreckage

Blaming the credit crisis on investments in collateralized debt obligations doesn't tell the whole story.
Stephen TaubApril 4, 2008

Some CDOs are more equal than others.

While many people who follow these arcane instruments reflexively associate collateralized debt obligations (CDOs) with credit deterioration in general, Moody’s stresses in a new report that the deterioration in 2007 was almost wholly contained to a single sector: U.S. dollar-denominated resecuritizations. Outside of this sector, rates of rating downgrades in 2007 were lower generally than their historical averages. “A review of the CDO market’s credit performance in 2007 underscores its diversity,” says Moody’s senior vice president Danielle Nazarian. “While subprime RMBS-backed resecuritization CDOs underwent widespread and severe downgrades, other key CDO sectors performed well, including those tied to the U.S. and European corporate-credit markets.”

Moody’s downgraded a total of 1,331 tranches of U.S. dollar-denominated resecuritizations in 2007. These accounted for 92 percent of the 1,448 downgrade actions for all CDOs during the year.

Within the dollar-denominated resecuritization category, downgrades were heavily concentrated in the 2006 and 2007 vintages. These two groups alone represented 87 percent of the total number of downgrades.

Looking ahead throughout 2008, Moody’s projects even greater ratings volatility among U.S. dollar resecuritization CDOs as signaled by the nearly 2,000 tranches currently under review for downgrade.

The rating agency says the rates of downgrade in other sectors for 2007 were fairly comparable to those observed in 2006. The two exceptions were the market-value CDO category, whose downgrade rate increased from zero in 2006 to 7.5 percent in 2007, and the investment-grade arbitrage cash-flow CBO sector, whose downgrade rate actually dropped from 10 percent in 2006 to zero in 2007.