Friday, January 25, 2008

CPDO Investors May Lose 90% as ABN Funds Unwind

(Bloomberg) -- ABN Amro Holding NV clients face 90 percent losses on two credit derivative products totaling 120 million euros ($176 million), according to Moody's Investors Service.

The so-called constant proportion debt obligations have seen their net asset value fall to 10 percent, meaning they will have to unwind, or ``cash-out,'' Moody's said in an e-mailed statement today.

CPDOs are securities that pay investors from income earned by selling credit-default swaps, contracts used to speculate on credit quality. The ABN Amro notes, issued under the bank's SURF program, reference contracts based on the debt of financial companies, whose credit quality has deteriorated in the wake of losses linked to U.S. subprime mortgages.

``The transactions will unwind at an approximate 90 percent loss to investors,'' Moody's Paris-based analysts Anne Le Henaff and Bongani Dlamini wrote in the statement. Credit-default swaps backing the deals have been ``continually increasing over recent weeks,'' analysts said.

Credit-default swaps on the Markit iTraxx Financial index of 25 European banks and insurers soared to a high of 84 basis points this week on concern credit rating downgrades at bond insurers including Ambac Financial Group Inc. and MBIA Inc. will cause bank losses to surge. The index traded as low as 20 basis points in November.

Debt Repayment

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

Banks led by Citigroup Inc. and Merrill Lynch & Co. have a net $1 trillion at risk because of contracts with insurers, according to the International Swaps and Derivatives Association. Fitch Ratings cut Ambac's top grade last week and Moody's Investors Service and Standard & Poor's are reviewing the New York-based company, along with the largest of the so- called monolines MBIA Inc., for possible downgrade.

The average risk premium on ABN Amro credit-default swaps rose to 201 basis points on Jan. 22, from 101 basis points on Jan. 2. A basis point on a contract protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year.

Moody's withdrew ratings on three other CPDOs sold by Zurich-based UBS AG because the deals are being restructured, it said in a separate statement. The deals, totaling 220 million euros, were rated either Ba2 or Caa1, seven steps below investment grade.

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