Remember When the Carina CDO Was Ordered Liquidated – Well There is Another One

It appears that the best action to take if you are the controlling interest in a CDO is to liquidate to preserve the capital remaining. This one is smaller ($487MM), but still it says the CDO market is illiquid and it is “best to get, while the gettin’ is good”. Text in bold is my emphasis. From the WSJ:

In another troubling sign for jittery investors, an additional mortgage-related investment vehicle battered by rising defaults among subprime borrowers is being forced into liquidation.

Bond-rating firm Standard & Poor's said late Tuesday it had been informed that the controlling investors in Adams Square Funding I Ltd., a collateralized-debt obligation, had directed the sale of mortgage-backed securities held by the investment vehicle.

CDOs are investment vehicles that hold pools of mortgages and other assets and issue bonds to investors with different levels of risk and return. The controlling class in a CDO is the group of investors who hold the highest-rated securities issued by the CDO. In some circumstances, they can force liquidation to recoup their investment. (Now you know why they are forcing the sale if they are the highest rated portion of the CDO.)

Adams, which had issued $487 million in notes to investors, is managed by Credit Suisse Alternative Capital Inc. S&P was notified Nov. 16. Two weeks earlier, a larger CDO known as Carina notified the rating firm that it was liquidating. As a manager, the Credit Suisse Group unit didn't suffer losses in the CDO, according to a person familiar with the matter, but it could forgo fees it would have earned for managing the product. It isn't clear who were the controlling investors that forced the liquidation.

The winding down of CDOs marks a new phase of the mortgage-securities crisis. The liquidations follow "events of default" that occur when certain terms of the CDO are breached. A breach can be caused when rating services like S&P downgrade their assessment of mortgage-backed securities held by the CDOs, undermining their standing as collateral. Since the summer, S&P and Moody’s Investors Service have slashed ratings on thousands of mortgage-backed securities and CDOs.

Adams's liquidation notice prompted S&P to slash its ratings on several classes of securities associated with the CDO, some by as much as 18 notches. Two classes of the CDO previously rated triple-A were dropped to junk-bond levels, with one going from triple-A to triple-C-minus, a level associated with a high risk of default.

Such liquidations represent a decision by senior CDO noteholders that the best course is to wind down the CDO by selling underlying assets and keeping the proceeds, a sign of low confidence in the market.

Since mid-October, S&P has received event-of-default notices for 28 such CDOs, ranging in value from $285 million to $2.3 billion. Two have indicated they will proceed to liquidate.