Constant Proportion Debt Obligation - Initial Reaction

Initial Reaction

The first CPDO deal was issued in 2006 by ABN-AMRO and was rated AAA/Aaa despite paying Libor plus 100bp. Many analysts were initially sceptical of the rating assigned, particularly since the deal contained a majority of market risk (spread risk) rather than credit risk - an area not normally covered by rating agencies. A few months later, Moody's release a comment to the effect that, while they still stand by their original rating, they acknowledge that the rating is highly volatile compared to other triple-A rated instruments. They also indicated that future deals would be highly unlikely to achieve the same rating with the same spread. Fitch Ratings in April 2007 released a report warning the market on the constant proportion debt obligations (CPDO) dangers.

Later CPDOs had more conservative structure and were offered at AAA/Aaa with a much lower spread.

Financial Times reported on May 21, 2008 that an investigation by FT has discovered that Moody’s awarded incorrect triple-A ratings to billions of dollars worth of a type of complex debt product due to a bug in its computer models. Internal Moody’s documents seen by the FT show that some senior staff within the credit agency knew early in 2007 that products rated the previous year had received top-notch triple A ratings and that, after a computer coding error was corrected, their ratings should have been up to four notches lower.