Derivative Fitch: Case Study of First Vintage of CPDO.

NEW YORK -- Derivative Fitch has today published a special report on the results of its case study on the potential performance and ratings of first generation constant proportion debt obligations ("CPDOs"). The key findings are:

-- First-generation CPDO transactions' performance and ratings are sensitive to even a minor amendment of the key risk parameters: spread volatility, roll-down benefit, bid/offer levels, and, to a lesser degree, default risk.

-- The sensitivity of a CPDO rating towards change in assumptions increases with higher rating levels and easily leads to rating changes of several categories.

-- Data on key performance parameter is only available for a little more than four years when the tenor of a CPDO is typically 10 years.

-- The leverage employed contributes to the sensitivity to key performance parameter and potential rating instability.

-- Corporate CDOs are more robustly structured against worst case scenarios than CPDOs at a comparable rating level.

-- Scenario analysis through historical back-testing showed that many of the more common CPDO structures would probably not have been able to withstand high investment-grade stresses.

-- For these reasons, first generation CPDOs do not achieve high ('AA'/'AAA') investment-grade ratings.

-- Second-generation CPDOs improve on shortcomings of the first.

CPDOs are one of the latest product innovations seen in the structured credit markets. Like other more recent structured credit products, the performance of the issued debt obligations is highly dependent on the mark-to-market impact of changes in credit spreads. Credit risk as measured by defaults and recovery rates becomes secondary. The market value of the exposure is typically driven by the CDS premium to be paid for protection on a portfolio of credit risky names, or a credit index-like iTraxx or CDX.

The key performance parameters for first-generation CPDO are spread volatility, roll-down benefit, bid/offer levels, and to a lesser degree default risk, and Derivative Fitch has been asked to rate numerous of these CPDOs. Derivative Fitch has carried out intensive research in these parameters that can influence the performance and hence the achievable rating of a CPDO.

Derivative Fitch's report "First Generation CPDO: Case Study on Performance and Ratings" explains how assumptions on the key performance parameters of a CPDO can be derived and demonstrates the sensitivity of achievable CPDO ratings towards adjustments to these input parameters. It also shows a CPDO's stress robustness in relation to the robustness of a corporate CDO.

Derivative Fitch is reviewing several proposals of next-generation CPDO that seek to address the shortcomings of the first vintage. The report is available for download at www.derivativefitch.com.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.derivativefitch.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site. Fitch means Fitch, Inc., Fitch Ratings, Ltd. and their subsidiaries including Derivative Fitch, Inc. and Deriva-tive Fitch Ltd. and any successor or successors thereto.