I have to admit that I had missed the trial in Sydney. I wasn’t aware that it was going on, but do intend to catch up on it. CPDO was quite possibly the worst of all the products. The more leverage, the better the rating. It has been a personal favorite of mine that this could be rated. At least I understood super senior and even the need for leveraged super senior, but the CPDO product felt completely wrong from the start. It was one of the products that pushed IG7 (I think) to record tights. What other product allowed you to take a BBB+ average portfolio, leverage it, and get AAA?
Everyone got sucked into a few fundamental flaws in the analysis – mean reversion was set to the wrong mean, curves don’t have to be steep, and the cost of exiting a stressed credit was underestimated.
I remember creating synthetic CDX indices based on TRACERS that showed CPDO would have triggered out, I wish I still had that write-up.
I will try and get details on this, but have to admit that it seems weird this was so far off the radar screen and the only people who seem to care are the Sydney Herald and The Age.
As wrong as the product was, and the allegations made by the purchasers, I have to wonder what they were thinking when they bought this stuff in the first place. Wasn’t it obviously complex at the time?
Scheme ‘Grotesquely Complicated’
2011-11-21 16:01:18.644 GMT
By Elisabeth Sexton
Nov. 22 (Sydney Morning Herald) — THE company that bought
$49 million worth of a “grotesquely complicated” structured
finance product for onsale to local councils in 2006 was
struggling financially and losing market share to its
competitors at the time, the Federal Court heard yesterday.
Local Government Financial Services Pty Ltd needed an
injection of $15 million to retain a credit rating from Standard
& Poor’s, its former head Warwick Hilder told the court.
The injection was provided by the NSW Local Government
superannuation scheme, which bought LGFS in 2004.
Mr Hilder, now retired and a former general manager,
financial markets, at NSW Treasury Corporation, was one of just
four employees of LGFS. Its key business activity in 2006 was
“providing investment management services and facilities for
local government entities in NSW,” he said.
Many of the 183 local councils in NSW were buying
structured finance products called collateralised debt
obligations, or CDOs, from rivals including Grange Securities
(bought by the US investment bank Lehman Brothers in 2007).
“Everyone was looking at new things to do with these
products because Grange had made so much money out of them,” Mr
He agreed with Simon Couper, QC, for LGFS’s insurer
Chartis Australia, that interest on the $15 million capital
injection exceeded all other income in 2005.
“The decision was then taken that the salvation for
LGFS was to become a product-seller?” Mr Couper asked.
Mr Hilder disagreed with the word salvation but said:
“That’s one way of looking at it.”
“What you were looking for was a product which would
compete successfully with CDOs?” Mr Couper asked.
Yes, Mr Hilder replied.
In 2006 LGFS decided on a product called a constant
proportion debt obligation, or CPDO, which Mr Hilder said had
similarities with and differences to a CDO.
In a paper for the LGFS board, he described it as
“grotesquely complicated”. He said yesterday: “I was having a
bad day when I wrote that.”
The CPDO, sold by the investment bank ABN AMRO, now
part of Royal Bank of Scotland, was very complicated in its
mechanics but simple in principle, he said.
Thirteen councils that lost 93 per cent of the $16
million they invested in the CPDO are suing LGFS, ABN and the
credit rating agency that assigned it a AAA rating, Standard &
LGFS, which retained some of the investment itself on
which it lost $16 million, is also suing the bank and the rating
The Sydney Morning Herald
Copyright © (2011) Fairfax Media Publications Pty Limited.
www.smh.com.au. Not available for re-distribution.
-0- Nov/21/2011 16:01 GMT