CDOs of ABSs reach events of default

Ninety-eight collateralised debt obligations of asset-backed securities (CDOs of ABSs) rated by Standard and Poor's (S&P) have reached so-called events of default (EODs).

The agency reported 98 deals issued between 2006 and 2007 had reached an EOD by February 13. The figure includes cashflow, hybrid, mezzanine and high-grade CDOs of ABSs, as well as CDO-squared transactions.

"Nearly all CDOs of ABSs originated in 2006 and 2007 are in deep trouble," says Ratul Roy, head of structured credit strategy at Citi in New York. Continual tranche downgrades among mezzanine CDOs of ABSs are in turn putting more high-grade CDOs of ABSs at risk, he adds.

High-grade deals, by definition, contain better-quality assets than their mezzanine cousins. But many of them also contain tranches of other CDO of ABS transactions.

These tranches, like their underlying ABS collateral, are now starting to affect high-grade CDO of ABS transactions. "As CDO of ABS downgrades continue, more high- grade deals will end up in default. The CDO bucket in these deals will be the biggest factor in their demise," Roy claims. Most recently, S&P downgraded 49 mezzanine CDO of ABS tranches - totalling $5.7 billion - on February 14.

EODs can be reached by various means, including a decline in the amount of over-collateralisation within a CDO of ABS vehicle, or falls in ratings of its underlying components.

Once an EOD occurs, senior noteholders can opt to accelerate the structure's cash waterfall or press for liquidation of its assets. Acceleration generally diverts its remaining cash towards more senior investors and away from the CDO's junior tranches. If the CDO is liquidated, its assets are sold off and the proceeds used to pay investors according to a cash waterfall.

Among the 98 CDOs of ABSs that have reached an EOD, Citi analysts believe five have already liquidated, while another 15-20 remain close to liquidation. "Liquidating is more difficult than just accelerating," explains Roy. "Many transactions will require the agreement of not just the most senior AAA-rated noteholders, but of other classes as well."

Fire sales by liquidating CDOs of ABSs will help drive down the already dismal prices being commanded by their underlying assets, analysts say.

Mark Pengelly.

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