Like their high-yield arbitrage counterparts, synthetic collateralized debt obligations have suffered an increasing number of credit events and downgrades in the past few months, due in part to the deteriorating corporate credit environment.

Although the most publicized of the downgraded deals were those with exposure to the California utilities (the Bistro deals), at least one analyst predicts that the market is not out of the woods yet.

Unlike high-yield CDOs, most of the synthetics took their hits because of so-called "fallen angels," analysts said.

"We've seen a surprising number of what the market calls fallen angels,' or companies that were previously investment grade, that have fallen to non-investment grade status, or have gone from investment grade to default," said Roger Merritt, an analyst in the CDO group at Fitch.

Of the synthetic deals with problems, most are synthetic balance-sheet CLOs, where the banks are transferring the risk from a highly rated group of reference obligations, most often for reasons of regulatory capital relief.

"So unlike the downgrades we've seen in the high yield CDO structures, these are being driven by selective problems with investment-grade credits in the underlying transactions," Merritt said.

The deterioration of investment-grade corporate credit is a complicated story, analysts said. While the slowing economy has been a contributing factor, there have been other unrelated, but timely events.

For example, the corporate downgrades of Owens Corning and Owens-Illinois were related to asbestos litigation issues.

Year to date, Moody's Investors Service has downgraded the debt rating of nearly 20 previously investment-grade corporations, affecting more than $9 billion in outstanding debt.

Though Fitch confirmed the trend, Merritt would only name BarCLO as an example of a deal with action taken against it by the agency. BarCLO is a synthetic CLO that was issued by Barclays Bank in 1999.

Moody's has knocked the ratings of several tranches from various synthetic deals in the past few months, including Bistro, BAC Synthetic CLO 2000-1, Blue Stripe 1999-1, York Funding and Eisberg Finance Ltd.

The agency would not comment for this story, but indicated that it is planning to issue a special comment on synthetic CDO downgrades.

Because Standard & Poor's only rated the senior tranches of deals like Bistro, the agency said that it has only downgraded one synthetic deal in the past few months: York Funding.

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