Collateralized Debt Obligation

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Collateralized Debt Obligation (CDO)

Collateralized Debt Obligation

An asset-backed security backed by the receivables on loans, bonds, or other debt. Banks package and sell their receivables on debt to investors in order to reduce the risk of loss due to default. Returns on CDOs are paid in tranches; that is, the individual loans backing each CDO have different levels of risk, and investors are paid out according to the level of risk they have acquired. Banks offer higher interest rates to investors willing to buy CDOs backed by higher-risk loans. From a bank's perspective, in addition to reducing risk, CDOs also reduce their capital requirements because they can raise funds through the issue of CDOs. While, theoretically, CDOs can be backed by mortgages, one usually refers to these as collateralized mortgage obligations.

collateralized debt obligation (CDO)

A debt security collateralized by a variety of debt obligations including bonds and loans of different maturities and credit quality.
Case Study Collateralized debt obligations (CDOs) originated in the 1990s when financial institutions began moving debts off their balance sheets by selling new securities (CDOs) using bonds and loans—often of relatively low credit quality—as collateral. Each CDO package permits investors to choose particular securities of different risk, ranging from investment-grade to very speculative. A CDO is considered high quality when it enjoys first claim on cash flows produced by the package of loans and bonds. This safety results in high-quality CDOs promising investors relatively low rates of return. CDOs with a lower claim to a package's cash flows carry a high rate of return because of the increased likelihood that some of the payments from the underlying collateral will not occur. Many CDOs were issued with low-grade bonds as collateral at a time when junk bond defaults were in the range of 2% to 3%. The subsequent meltdown of telecommunications and other high-tech firms in 2000 and 2001 resulted in increased defaults on debt that caught many CDO investors by surprise. In fact, the sudden decline in credit quality surprised even professional investors. Financial services company American Express was forced to take pretax writeoffs of over $1 billion in the first seven months of 2001 to account for the decreased market value of the CDOs and other debt securities held in its portfolio. Bank One and insurance companies Lincoln National, American General, and Torchmark were also forced to take large writeoffs on CDO holdings.
References in periodicals archive ?
Kiwane is a joint venture between Gensec and black empowerment company Real Africa Durolink, set up to run collateralised debt obligation funds.
13 February 2014 -- Utah US-based bank holding company Zions Bancorporation (NASDAQ: ZION) said it has closed the sale of collateralised debt obligation securities that it identified for sale as of December 31 2013.
The US regulators are examining whether Merrill had incorrectly priced assets for the USD1.5bn collateralised debt obligation, and whether it told buyers that Magnetar helped select the assets included in the CDO, and then bet against those same assets, the report said, citing unnamed sources.
In its quarterly report filed with the Securities and Exchange Commission, Morgan Stanley said that it has reached a settlement with US Bank over its role in a collateralised debt obligation - Tourmaline CDO I.
Germany's Deutsche Bank AG (NYSE: DB) (DBK.XE) has said that its European head of asset-backed and collateralised debt obligation trading, Pius Sprenger, would assume global responsibilities in those functions.
Paris/Frankfurt: Fitch Ratings has updated its covered bonds and collateralised debt obligations (CDOs) public entities' asset analysis rating criteria.
The firm's top executives are also said to be toying with the idea of expanding structured credit, especially collateralised debt obligations, or CDOs.
Legal & General Group Plc (Legal & General) today announced it has unwound 4 collateralised debt obligations (CDOs), held within Legal & General Retirement, totalling over 1 billion.
Newcastle operates as a real estate investment trust in the US and invests in and manages real estate related and other investments, including senior housing properties; debt investments financed with collateralised debt obligations; other debt investments; and investments in golf courses and facilities.
NRAM claims that the Swiss bank "knowingly packaged impaired" financial products, including collateralised debt obligations and residential mortgage-backed securities, and sold them to Northern Rock for a high price, despite knowing they were shoddy.
Mashreq claims it invested conservatively with ING in 2005, and that in 2007 ING made changes to the investments without its authorisation; revisions included collateralised debt obligations and other risky instruments, reported Bloomberg, citing a complaint filed on Tuesday (9 April) in Manhattan federal court.
The United States accused S&P of knowingly inflating its ratings on collateralised debt obligations and residential mortgage-backed securities in 2007 in order to win revenue from issuers.