Sutherlands Edinburgh

2007-04-27

Comment: ABN's AAA rating for its CPDO (Constant Proportion Debt Obligation) is a reflection of the interest payment rating but does not appear to fully encapsulate the risks of investing in the vehicle to maturity. There is virtually a zero probability of default for any payments up to maturity - which would give a AAA default distribution until the maturity date. If there is an underperformance of the underlying fund there may be a shortfall at maturity.
The fund could get into trouble if it experiences poor investment performance in the early years, which would then mean it would be required to leverage up to a maxiumum of 15x to compensate for the initially low returns. The principal behind this is that once credit spreads have widened (the fund has lost money), it can then gear up and take advantage of a reversion (down) to a "normal" level of credit spreads. However, if this does not happen, an even larger loss could be experienced. This would not affect interest payments but could mean a shortfall at maturity. The flip side of this argument is that if the fund performs well in the initial years there will be no need to gear the underlying fund up to such a high level and a high rating could be justified