Looking back on the past two weeks, one might think triple-A arb cashflow HY- bond CDOs in the 1999 vintage appear under siege by the rating agencies: at least 11 tranches across seven transactions saw their triple-A wings clipped between Jan.28 and Feb. 7, 2002.

If that wasn't bad enough, 16 tranches of mostly 1999-2000 vintage CDOs, spanning seven deals, had triple-A tranches put on negative watch lists.

"The frightening thing is that there are dozens of CDOs with double-digit default buckets and swelling amounts of triple-C bonds that the rating agencies have not gotten around to taking action on," commented one trader. The trader added that he refuses to buy subordinate triple-A CDOs. Of the seven deals with triple-A downgrades, all were transactions in the 1999-2000 vintage, with one exception.

Although some may claim "a triple-A is a triple-A," this is not the case when the tranche is subordinate in a CDO cashflow waterfall. According to bankers, Standard & Poor's takes a harsh view on subordinate triple-As, since the agency rates to the first- dollar loss. Hence, this is why these triple-As frequently price close to double-A rated CDO tranches.

The start of February saw two eye-popping, nine-notch drops from triple-A down to triple-B minus on four Bear Stearns underwritten sub tranches. S&P hit two subordinate tranches on the South Street CBO 1999-1 Ltd: Class A-2L and A-2, ranked pari passu.

As of the Jan. 17, 2002 South Street's trustee report showed 12.4% of the collateral pool in default.

Additionally, Fitch Ratings kicked two subordinate triple-A tranches of the CHYPS CBO 1997-1 Ltd. down to triple-B minus.

But where there's volatility there's opportunity, and dealers note a strong bid for distressed triple-A paper. Also, some sophisticated investors are seeing good value in distressed CDO paper at all levels of the capital structure.

For example, a U.S. investor purchased a block of triple-B cashflow notes of a severely wounded 2001 static pool, synthetic investment-grade CDO with a modeling assumption of a 40% total return, using a 0.0% default rate on the investment. The 2001 vintage deal, currently PIKing (payment-in-kind), had the misfortune of having Enron and Swiss Air help wipe out the entire equity tranche and part of the triple-Bs.

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