Wachovia Securities CDO analysts last month sought to find a new way to answer an old question: Is there a method to project future new-issue CDO performance using historical data? Their ultimate finding was yes, although with some caveats.
In a nutshell, the idea is to use historical ratings and recovery data, by CDO type and credit level, in order to derive a risk-adjusted return when applied to current spread levels. The risk adjusted return would provide a value for how well the securities would fare now, assuming they performed identical to historical averages. The CLO sector came out smelling rosy under the methodology - as it was the only group to display positive returns all the way down the capital structure. "I think this is a good way to benchmark relative value across sectors, but I wouldn't focus on one number," said Steven Todd, a senior analyst at Wachovia. "I would look at the general trends, and then examine how sensitive the relative value rankings are to rating transition and recovery assumptions."