Research into recovery rates on collateralized debt obligations of CDOs shows that typical CDOs of CDOs will produce low recoveries. Most CDOs squared are referenced to slithers of CDOs with attachment points of around 5% and exhaustion points of 7%. This means that the tranche is only 2% of the whole deal and if there is a default it is quickly eaten through, according to Fitch Ratings. Structurers said they make the slices thin to increase the leverage and diversity.
Matthias Neugebauer, director in the European structured finance group in London, said, "The recovery rate on the master tranche is a function of the thickness of the underlying." The graph shows that the recovery rate keeps increasing until the underlying tranche reaches around 10% of the deal.
