Collateralized Debt Obligations: Structures and Analysis, Second Edition

CHAPTER 24

CDO Rating Experience

In this final chapter, we look at how CDOs have performed by rating level and types of collateral. In particular, we look at Moody's CDO rating actions on 1,049 CDOs and 3,014 CDO tranches across 22 types of CDOs and eight years of issuance. Our unique contribution to rating transition studies is a vintage-by-vintage comparison of the frequency and severity of cumulative CDO rating downgrades across different types of CDOs. This includes an analysis of the most severe downgrades, also by both vintage and CDO type.

We are conscious that there have been criticisms of the timeliness and subjectivity of ratings actions. Even so, no other CDO performance statistic has the potential to encompass all the quantitative and qualitative factors that comprise a CDO's credit quality.

We will see that most of the CDOs that experienced high downgrade frequency and severity suffered from one of two problems. For many arbitrage CDOs, poor performance was the result of an imbalance between collateral spreads on the one hand and CDO debt spreads and targeted equity returns on the other. The difficulty of satisfying all CDO constituents tempted CDO managers into low-quality, high-yielding, and misrated assets. For many balance sheet CDOs, poor performance was the result of using the CDO structure to offload credit risk upon unsuspecting CDO investors. But both of these specific manifestations arose out of a more fundamental CDO problem: poor management of the conflict ...