25 CDOs to meet their maker; billions poised to liquidate

Beginnings of a CDO firesale? After two months of tension, all of a sudden, senior debtholders can’t seem to liquidate their CDOs fast enough.

FT Alphaville understands that 25 CDOs are currently being “accelerated” - half of the 50 Moody’s tells us are now in Events of Default. Acceleration is typically a precursor to the liquidation of a CDO, for it declares all the notes to be immediately due and payable, enforcing a true capital waterfall.

Separately, Reuters reports on several liquidations they’ve heard of going through in the next few days:

Managers of several so-called collateralized debt obligations are liquidating more than $5.0 billion of distressed securities from their portfolios over the next few days, market sources said on Tuesday.

One auction occurred late Monday and two other auctions are slated for later Tuesday. The auctions total $1.5 billion for the “TABS 2006-5″ portfolio, which includes collateralized mortgage obligations, other CDOs and home equity ABS securities.

And another auction is being held on Wednesday - the $1.56bn Carina CDO is being liquidated. On Thursday, TABS 2007-7, with $2.3bn under management, will also have its assets auctioned off. This latest round of liquidations comes on the back of three notices to liquidate at the end of December: Tricadia ($500m), Vertical ($1.5bn) and Adams Square Funding ($507m).

Why this sudden rash of accelerations and liquidations? Our money’s on this line from a Moody’s report sent out to CDO noteholders on Tuesday:

If an acceleration were to occur, there is a very good chance that the most senior class would actually warrant an upgrade.
When a CDO triggers an Event of Default, its fate lies with the most-senior noteholders, who decide what to do with it. Hitherto those most senior classes have been very reluctant to liquidate. Look what happened to Adams Square - liquidation proved to be the wrong decision, wiping out every tranche and eating into even the super-senior investors’ positions.

In light of Moody’s comments, that’s clearly no longer seen as the case. In many CDOs, acceleration and liquidation have become viable options recently for the “most senior” noteholders because of who those “most senior” investors are. As we’ve reported before, they aren’t actually noteholders at all, but in many cases, counterparties to swap agreements on the CDO portfolio - known as super-senior positions. Super-seniors then, as swap holders have little compunction in pushing the liquidation button, because it gets them out of a unwanted commitment to failing CDOs.

There are, of course, big variances here, which Moody’s are keen to stress. For some, going into acceleration doesn’t mean imminent liquidation, but rather, the ability to postpone a decision and guarantee the position of the super-seniors. Such is the decision being taken by many super-senior counterparties - the bond insurers. Moody’s
Monolines, who do not typically apply mark-to-market accounting, may weigh the liquidation and acceleration choices differently. They are more likely to prefer acceleration as a post-EOD remedy whereby losses may be spread out over a longer period of time.

But where does all this acceleration and liquidation talk leave actual noteholders - AAA investors and the like? Moody’s again:

…it is also very likely that all other classes will be downgraded more severely than if acceleration were not to occur.

How severely remains to be seen. Factoring in termination fines in event of liquidation - which impact synthetic CDOs; 75 per cent of the CDO market - losses might be expected all the way up the capital structure, eating right into AAA notes, if not wiping them out.