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 ?
At the same time, the FRBNY said it plans to sell at auction an additional $5.2 billion of collateralized debt obligations held in the Maiden Lane III facility.
A lawsuit against JPMorgan Chase, which has more than $2 trillion in total assets, claimed that the bank structured and marketed collateralized debt obligations (CDOs) without informing investors that the underlying subprime assets in the portfolio were selected in part by a hedge fund that was positioned to profit if the portfolio failed.
It sold collateralized debt obligations in tranches valued at $54 billion.
This was the latest enforcement action against Wall Street banks over the marketing of collateralized debt obligations prior to the 2008 financial crisis.
In May, JPMorgan said it was in "advanced" negotiations with the SEC to resolve the collateralized debt obligations.
The suit alleged that the bank had lied to investors about its exposure to collateralized debt obligations and other non-performing assets.
The UK Serious Fraud Office is investigating sales of credit-default swaps and structured-finance products, including collateralized debt obligations, prior to the credit crisis, following up an earlier investigation into a hedge fund and a related BVI-registered company, reports Bloomberg (Aug.
Gramercy made a cash payment of $45.0 million and agreed to pay over time an additional $15.0 million from a portion of free cash flow generated by the Company's collateralized debt obligations.
Life Insurers: Large Commercial Mortgage Exposure Under Control,' are strong capitalization and investment holdings of more highly rated commercial mortgage-backed securities (CMBS) and collateralized debt obligations (CDO).
If the major retail banks can't distinguish between real and phantom revenue streams by telling how many mortgage borrowers are going to have trouble making their monthly payment, what are investors to make of securitized catastrophe risk portfolios loaded with esoteric instruments like insurance-linked securities, sidecars and collateralized debt obligations.
"We have not invested in any high-risk mortgagebacked securities or collateralized debt obligations, which have been a source of significant concern or losses for most financial institutions that invested in them," he said.
With the subprime mortgage crisis roiling the economy, insurers and reinsurers are turning from collateralized debt obligations to less risky structures to replace lost investment income and boost portfolio performance.