AAA CDO´s revisited

Discussion in 'Wall St. News' started by ASusilovic, Jul 20, 2009.

  1. We heard last week that Morgan Stanley has begun making plans to repackage downgraded debt into a new tranche of AAA-rated securities. That technique essentially involves employing a Re-REMIC strategy typically used for CMBS-backed CDOs, to repackage a CDO backed by leveraged loans - a CLO. Meanwhile, Goldman Sachs and Barclays are said to be up to their own securitisation schemes.

    And late on Friday we heard of another new one, from Structured Finance News:
    CLO managers are finding creative ways to restructure their portfolios. Following Morgan Stanley’s announcement last week that it would repackage downgraded CDO tranches backed by leveraged loans into new triple-A-rated securities - the first strategy of its kind - Egret Capital has also come up with a new restructuring tactic.

    Egret earlier this week said it had bought back some of the debt in one of its portfolios, also a first for a CLO manager, according to Moody’s Investors Service. The London-based CLO manager and unit of Societe Generale said it used the interest proceeds from its Egret Funding CLO I Plc portfolio, which should have been paid to class M subordinate note holders, to retire €1.4 million ($1.98 million) of its class E deferrable floating-rate notes at 25% of the principal, Moody’s said. The purchased class E notes will be cancelled.

    Now, Moody’s is calling that a distressed exchange because it was made at a discount to the debt’s face value, hence the ratings agency downgrading the class E notes to C on July 9. However, as the article notes, that sort of rationale typically applies to corporate borrowers who are looking to avoid a bankruptcy filing or default — which Egret wasn’t. Thus the class E notes were promptly upgraded back to Caa1 once the buyback was completed, on July 13.

    In other words this is basically Egret acting like a corporate issuer and taking advantage of the dislocation in the debt market to buy back some of the bonds in its own portfolio at a deep discount. That has more than a touch of irony to it considering that the ratings agencies’ treatment of corporate buybacks has given CLOs more than a little trouble of late. From EuroMoney:

    Clearly any heavily indebted corporate that would be strengthened by buying back debt at a deep discounted price will be put off if the result is a downgrade to default. Perhaps even more worryingly, rating agencies’ policies on debt exchanges and buybacks are increasing the number of CLO vehicles that fail their junior overcollateralization (OC) tests. These vehicles are particularly sensitive to rating changes as their OC tests are severely impacted by triple-C and lower rated credits. Failure of OC tests can lead to an event o default for the entire vehicle, resulting in the forced liquidation of the entire CLO portfolio — exactly the last thing that this market needs.

    LMAO ! :D