from FinanceAsia.com"ABN AMRO continues to lead credit derivative innovation with its first-everConstant Proportion Debt Obligation ABN AMRO this week launched its first public constant proportion debt obligation (CPDO). This new form of synthetic credit investment carries a full AAA rating from Standard & Poors on both principal and coupon.It uses elements from both CDO and CPPI technology to produce a new non-principal-protected, fixed-income, credit-investment tool.The CPDO generates returns through exposure to a portfolio of credit default swaps (CDS) which is linked to highly liquid CDS indices. The size of the portfolio is adjusted dynamically so that the CPDO only uses the leverage it needs in order to make the scheduled principal and interest payments. The structure of the CPDO is designed to have a stable rating with a high likelihood of “cashing-in” to a risk-free investment that pays the stated coupon and principal at maturity."This is the most exciting development in the credit market for several years. The absence of a full rating has made it historically difficult for investors to assess the risks and appropriately place dynamically leveraged credit products into a portfolio. By creating the CPDO with a full rating for the timely payment of both principal and interest we have solved this issue for our institutionalinvestors and broadened the asset choice available to managers of credit portfolios," says Steve Lobb, global head of credit and alternative derivative marketing at ABN AMRO.He adds that the new product allows a wide range of investors who are restricted from investing in unrated securities to access credit instruments that use dynamic leverage for the first time. "

This is an "interesting" structure to say the least.ABN's lastest offering under this series is "SURF II" through the "CHESS II" SPV.Yes, it is true that it combines the CPPI and CDO technology. What is something of a mystry is how is this note able to get "AAA" rating for both, the principal AND interest.The note's structure, as with the CPPI, places the cash from the issue on Depo. However that is where similarities end. Under CPDO this depo is used as a cushion for potential payouts against leveraged (up to 15X) expoure to CDSs on DJ CDX and iTRAXX (50% wieghting for each). I was talking to someone who has invested in the product on the back of S&P & Moody's AAA-rating for the note. The investor thinks she is getting a good deal: a "AAA"-rated bond with LIBOR+250 for 10 years. BTW, any returns above 250bp are reinvested back into the structure to build up the capital to repay the principal at the end of 10 years.What she still is unable to figure out is, how can the rating agencies give "AAA" rating (which S&P and Moody's have given) to a note that has the following underlying iTRAXX constituents (leveraged upto 15 X):AAA: 2%AA: 2%AA-: 5%A+: 8%A: 13%A-: 18%BBB: 52%

pretty cool huh. leverage up big time a A-/BBB+ average rated portfolio and still get rated Aaa.What I read was that simulation of historical spread movements and default rates led to low probability of default on the structure (think less than 1%) hence the Aaa rating by Moodys/S&P. What I doubt however is whether investors realize the probability of a 30%-40% decline in the first year after the launch is rather high. Also, the time period used for the simulation didn't include the 1978/1982 recessionary period. Doubt it'll hold up as well if we ever get there. But hey, you gotta realize as a smart investor that L+250 for a AAA rated bond means there's some hidden risk. Let's hope it's not 'round the corner though.

Lepperbe, you are so right.yeh, it is pretty cool – especially for ABN.I just got a copy of the ABN presentation from their roadshow. The only factor that could be described as a mitigant – compared to , say, CDO – is that there is no correlation risk (there is no tranching). But in my view what makes this structure even riskier than an actively managed CDO is the fact that both DJ CDX and iTRAXX revamp/roll the indices only once every six months. So lets say the market receives bad news about Company “A” in March. Managed pools (e.g. CDOs) would start to dump “A’”'s Credit Obligations straight away. But iTRAXX can only offload “A” when the index is due for roll next – in September!Another interesting characteristic of this structure is that if the structure performs well in the earlier years (and therefore on target to meet the 250bps promised coupon to maturity), then the leverage will be moderate (or may even be brought down) because the product does not need the extra leverage to meet its obligations at maturity. However – wait for this! – if the structure does not perform well in the earlier years, then it will be levered up to the limit (15 times) to “catch up” on the lost returns. This to me sounds like saying that the bus-driver who takes my kids to school will drive carefully and within the limit when the roads are clear, the weather is good, and the bus is on-time. But if the bad weather causes traffic jam and he is running late, he will put his foot down on the gas even if the snow storm is still raging and the roads are still icy – just because he wants to reach the school on time. It would be interesting to hear why are the rating agencies prepared to certify that these notes effectively carry the same risk as US Treasuries or Gilts. No wonder so many people are talking about the “moral hazard”; Rating agencies have got so used to making a lot of their money from structured credit that investors need to take ratings with a pinch of salt.

QuoteOriginally posted by: IceQueenHowever – wait for this! – if the structure does not perform well in the earlier years, then it will be levered up to the limit (15 times) to “catch up” on the lost returns. This to me sounds like saying that the bus-driver who takes my kids to school will drive carefully and within the limit when the roads are clear, the weather is good, and the bus is on-time. But if the bad weather causes traffic jam and he is running late, he will put his foot down on the gas even if the snow storm is still raging and the roads are still icy – just because he wants to reach the school on time. Very nice analogy.The whole structure is based on mean reversion of spreads and leverage up when things are going against you and wait for spreads to revert to more normal levels. Pretty much what LTCM did although probably with lower leverage in this structure.In the long run spread will revert to their mean (I guess), but I'm reminded of the phrase by Keynes about markets remaining longer irrational than you can remain solvent.

Very interesting, to say the least.Does anyone have their presentation on pdf?

Hi, yea seems really interesting... can someone send me the presentation??Isn't it a bit familiar to the Credit SPI by Morgan?? That also is a CPPI structure applied to credit.

If someone could send me the presentation too,

Agree with Lepperbe the structure make sense if one belives in mean reversion in credit market-- i think it makes much more senese than original CPPI given exploding mean reversion behaviour of spreadsBtw the only 5-10% of CDOs are managed so most of the CDO investors will the same if not worst problems in the case of idiosyncratic events.Icequeen it sounds you are a bit jelaous abt this structure

Hello,I would greatly appreciate to look at the presentation.Thank you

I have been following this for a while now and think that I kind-of understand the structure. Generally speaking, it appears the market seems to accept it as an investible structure (oyu can tell this by the number of banks replicating, if there was no demand, no-one would bother trying to deliver). I hear that the majority of trades are being done for "sophisticated investors" and they prefer this to cppi because they believe in the mean revsersion of spreads mentioned by Lepperbe below. I tihnk IceQueen has been a bit harsh as she implies that it follows the "gambler's ruin" strategy of doubling up your investment when you lose; if it does snow then the bus does go faster but the cppi rules ensure that the bus is fitted with a speed limiter! In delta terms, if you view cppi as a call option, I guess the CPDO structure can be viewed as a butterfly and I guess that there is a place for both strategies in investor's portfolios.

As far I was aware these were rated for principal only? The moody's presale doesn't say anything about interest, just that the rating addresses the "expected loss" at maturity -i.e. principal. Are S&P actually rating interest as well, or is that media misreporting? I don't have the presale for them... anyone?

FITCH published an interesting article on 19 oct...

would some one also be able to send me any presentations on this structure pls. thanks

would some one also be able to send me any presentations on this structure pls. thanks