In a research report ominously titled, "Distressed CPDOs: We're Doomed!" CreditSights told clients credit derivatives known as CPDOs, constant proportion debt obligations, may be as likely to default as high-risk bonds. CPDOs use credit-default swaps -- an insurance contract that pays a buyer face value if the borrower does not pay its debt -- to bet that a group of investment-grade companies will repay its debt. If those companies' credit ratings are downgraded, the CPDO will see losses. "If you assume defaults and downgrades come in bunches rather than being evenly spaced out, CPDOs' default rates are more what you would expect for low junk ratings than for AAA," CreditSights analyst David Watts said in an interview. Credit rating drops of companies has caused some CPDOs to lose to 70% of face value. "Even a relatively small number of downgrades" will create a scenario where "CPDOs will suffer and their ability to repay par at maturity will be far from certain," he said. Banks have set up at least $4 billion in the derivatives, which first appeared in 2006. If unable to pay buyers, the fallout could bring even more negative attention to credit-rating companies and their part in the crisis. A recent plunge in the mortgage and housing sectors has brought heat on investment grading companies like Moody's and S&P, because they are failing to downgrade companies until their stock price has dropped significantly. Senate Banking Committee Chairman Christopher Dodd put the spotlight on these agencies last month when he asked why they awarded "AAA ratings to securities that never deserved them."
Commentary: Moody's Downgrading Subprime Mortgage-Backed Securities; S&P to Follow • Short Moody's • Credit Rating Companies: Subprime's Latest Casualties • CDOs and Rating Agency Risk
Stocks/ETFs to watch: MCO, MHP
Earnings call transcript: McGraw-Hill Companies Q2 2007
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