Friday, November 9, 2007

State Street May Be Liquidating a CDO - This Could Be the "Big One"

As of this time there is some question as to whether or not this is occurring, but it appears that State Street may be liquidating a CDO. Evidently this is being required by the major note holder and is in response to a downgrading of the debt by S&P. This is important because it will give an indication how the market will react to liquidation and value State Street will receive. This could make the make the news for the rest of the year very interesting because it could help define the value of CDOs on a good day and on a bad day it cause panic selling in the credit markets. Maybe the big news for the month is not the Michigan - Ohio State game. Text in bold is my emphasis. From Yahoo:

The trustee of a $1.5 billion collateralised debt obligation (CDO) managed by State Street Global Advisors has started selling assets, apparently starting a process of liquidation, Standard & Poor's said late on Thursday.

The news from the ratings agency raised worries of similar action on a wider array of structured securities, and stirred more fears about the exposure of U.S. financial institutions to credit markets.

S&P said it slashed its ratings on Carina CDO Ltd's top tranche of securities by 11 notches to the junk level of BB from the top-notch triple-A after it received a notice on Nov. 1 saying that the controlling noteholders had told the trustee to liquidate.

S&P also chopped its ratings on the subordinate levels of the CDO, with two falling to CCC- and eight to CC. The ratings were first assigned in November 2006.

The trustee of the Carina CDO has started selling the asset-backed securities -- residential-mortgage backed securities and CDOs -- making up the CDO at the direction of the structure's noteholders, S&P said.

"We believe the liquidation process has begun," S&P said in its statement. CDOs repackage assets ranging from mortgages and credit-card receivables to corporate bonds into securities. The tranches of a CDO are divided so returns depend on credit risk, with the lowest tranches the first to suffer from any asset defaults.

State Street declined on Friday to say whether the CDO it manages is being liquidated. However, the bank's spokeswoman said any decision to liquidate the CDO and the financial liability from that lie with the principal note holder, not State Street.

Ratings agencies have slashed the ratings of many CDOs and structured securities this year as surging defaults in U.S. subprime mortgages and the resulting credit crunch have hit the value of their underlying assets.

Last month, S&P put 590 ratings on 176 CDOs -- including those on Carina -- on watch for a possible cut, affecting $20.6 billion in debt.

The ratings cut on the Carina CDO is more severe than would be justified by the deterioration of the underlying assets because a decision to liquidate would depress prices and affect all notes that were issued, S&P said.

S&P said the ratings on the top two parts of the CDO would only be trimmed by one or two notches if the liquidation notice were withdrawn, but any selling will lead to material losses and market prices may not recover during the liquidation period.

The liquidation notice follows an event of default notice on Oct. 22, which occurred after a collateral trigger in the structure was tripped. That notice led Moody's Investors Service to slash its ratings on Carina on Oct. 30.

S&P said 14 CDOs have received such default notices, twice as many as the agency said had received the notices a week ago. But it said it had only received a notice of liquidation for Carina, not the other 13.

Credit analysts at Bank of America Securities said in a note to clients this week they expect more hefty asset write-downs tied to CDOs as "valuation uncertainty and further market erosions will imply continued increased losses."

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