A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS).[1] Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing mortgage-backed securities (MBS).[2][3] Like other private label securities backed by assets, a CDO can be thought of as a promise to pay investors in a prescribed sequence, based on the cash flow the CDO collects from the pool of bonds or other assets it owns.[4] Distinctively, CDO credit risk is typically assessed based on a probability of default (PD) derived from ratings on those bonds or assets.[5]
The CDO is "sliced" into sections known as "tranches", which "catch" the cash flow of interest and principal payments in sequence based on seniority.[6] If some loans default and the cash collected by the CDO is insufficient to pay all of its investors, those in the lowest, most "junior" tranches suffer losses first.[7] The last to lose payment from default are the safest, most senior tranches. Consequently, coupon payments (and interest rates) vary by tranche with the safest/most senior tranches receiving the lowest rates and the lowest tranches receiving the highest rates to compensate for higher default risk. As an example, a CDO might issue the following tranches in order of safeness: Senior AAA (sometimes known as "super senior"); Junior AAA; AA; A; BBB; Residual.[8]
Separate special purpose entities—rather than the parent investment bank—issue the CDOs and pay interest to investors. As CDOs developed, some sponsors repackaged tranches into yet another iteration, known as "CDO-Squared", "CDOs of CDOs" or "synthetic CDOs".[8]
In the early 2000s, the debt underpinning CDOs was generally diversified,[9] but by 2006–2007—when the CDO market grew to hundreds of billions of dollars—this had changed. CDO collateral became dominated by high risk (BBB or A) tranches recycled from other asset-backed securities, whose assets were usually subprime mortgages.[10] These CDOs have been called "the engine that powered the mortgage supply chain" for subprime mortgages,[11] and are credited with giving lenders greater incentive to make subprime loans,[12] leading to the 2007-2009 subprime mortgage crisis.[13]
^
An "asset-backed security" is sometimes used as an umbrella term for a type of security backed by a pool of assets—including collateralized debt obligations and mortgage-backed securities. Example: "A capital market in which asset-backed securities are issued and traded is composed of three main categories: ABS, MBS and CDOs" (italics added). Source: Vink, Dennis (August 2007). "ABS, MBS and CDO compared: an empirical analysis" (PDF). Munich Personal RePEc Archive. Retrieved 13 July 2013..
Other times it is used for a particular type of that security—one backed by consumer loans. Example: "As a rule of thumb, securitization issues backed by mortgages are called MBS, and securitization issues backed by debt obligations are called CDO, [and s]ecuritization issues backed by consumer-backed products—car loans, consumer loans and credit cards, among others—are called ABS ..." (italics added). Source: Vink, Dennis (August 2007). "ABS, MBS and CDO compared: an empirical analysis" (PDF). Munich Personal RePEc Archive. Retrieved 13 July 2013.
See also: "What are Asset-Backed Securities?". SIFMA. Archived from the original on 29 June 2018. Retrieved 13 July 2013. Asset-backed securities, called ABS, are bonds or notes backed by financial assets. Typically the assets consist of receivables other than mortgage loans, such as credit card receivables, auto loans, manufactured-housing contracts and home-equity loans.
^Lepke, Lins and Pi card, Mortgage-Backed Securities, §5:15 (Thomson West, 2014).
^Cordell, Larry (May 2012). "COLLATERAL DAMAGE: SIZING AND ASSESSING THE SUBPRIME CDO CRISIS" (PDF).
^Azad, C. "Collateralized debt obligations (CDO)". www.investopedia.com. Investopedia. Retrieved 31 January 2018.
^Kiff, John (November 2004). "CDO rating methodology: Some thoughts on model risk and its implications" (PDF).
^Koehler, Christian (31 May 2011). "The Relationship between the Complexity of Financial Derivatives and Systemic Risk". Working Paper: 17. SSRN 2511541.
^Azad, C. "How CDOs work". www.investinganswers.com. Investing answers. Retrieved 31 January 2018.
^ abLemke, Lins and Smith, Regulation of Investment Companies (Matthew Bender, 2014 ed.).
^McLean, Bethany and Joe Nocera, All the Devils Are Here, the Hidden History of the Financial Crisis, Portfolio, Penguin, 2010, p. 120.
^Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, aka The Financial Crisis Inquiry Report, p.127
^Cite error: The named reference FCIR-130 was invoked but never defined (see the help page).
^Cite error: The named reference FCIR-133 was invoked but never defined (see the help page).
^Lewis, Michael (2010). The Big Short: Inside the Doomsday Machine. England: Penguin Books. ISBN 9781846142574.
and 20 Related for: Collateralized debt obligation information
collateralizeddebtobligation (CDO) is a type of structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets...
different classes of owners in various tranches. A CLO is a type of collateralizeddebtobligation. Each class of owner may receive larger yields in exchange for...
A collateralized mortgage obligation (CMO) is a type of complex debt security that repackages and directs the payments of principal and interest from a...
Debtobligation may refer to: Collateralizeddebtobligation Constant Proportion DebtObligation This disambiguation page lists articles associated with...
simple versions of these structures being known as synthetic collateralizeddebtobligations (CDOs), credit-linked notes or single-tranche CDOs. In funded...
A synthetic CDO is a variation of a CDO (collateralizeddebtobligation) that generally uses credit default swaps and other derivatives to obtain its investment...
American businessman and investor known for having shorted collateralizeddebtobligations (CDOs), thereby profiting from the collapse of the US housing...
2000, the NRSROs were making substantial profits from rating collateralizeddebtobligations (CDOs), residential mortgage-backed securities, and other varieties...
collateralized fund obligation (CFO) is a form of securitization involving private equity fund or hedge fund assets, similar to collateralizeddebt obligations...
crisis was financed with mortgage-backed securities (MBSes) and collateralizeddebtobligations (CDOs), which initially offered higher interest rates (i.e...
securities, or collateralizeddebtobligations (CDOs). Investors are repaid from the principal and interest cash flows collected from the underlying debt and redistributed...
organ or vascular bed Collateralizeddebtobligation This disambiguation page lists articles associated with the title Collateral. If an internal link...
the credit default swap market who sought to bet against the collateralizeddebtobligation (CDO) bubble and thus ended up profiting from the financial...
event-driven strategies. The firm was actively involved in the collateralizeddebtobligation (CDO) market during the 2006–2007 period. In some articles critical...
City of Birmingham Symphony Orchestra Collateralized bond obligation, a type of collateralizeddebtobligation Columbium oxide (CbO), an alternate name...
finance, unsecured debt refers to any type of debt or general obligation that is not protected by a guarantor, or collateralized by a lien on specific...
Excessive consumer housing debt was in turn caused by the mortgage-backed security, credit default swap, and collateralizeddebtobligation sub-sectors of the...
associated with mortgage-related securities, which included the collateralizeddebtobligation (CDO) market. There were large losses in the CDO market that...
in the issue of asset-backed securities, collateralized mortgage obligations or collateralizeddebtobligations. Corporate issuers tend to prefer not to...
securities, such as mortgage-backed securities and collateralizeddebtobligations. The issuers of the obligations or securities may be companies, special purpose...