Other banks and asset managers that have issued or arranged CDOs have been watching the proceedings carefully — but they will have to wait before they can relax.
Almost immediately after the settlement was announced on Monday, northern Italy's Banca Popolare di Intra (BPI) filed suit in London against Bank of America, claiming compensation for losses on credit-linked notes structured and sold by the firm.
And, according to the law firm that filed the suit, it could be the first of many cases brought by disgruntled CDO investors against the London-based investment banks that sold them the products.
Dario Loiacono, of Milan law firm Loiacono e Associati, told EuroWeek: "Our law firm is pursuing several cases on behalf of different clients, in Italy and elsewhere, who bought credit linked notes. These are different clients, different products and different issuers. But all have common factors: problematic structuring, problematic selling and problematic substitutions in the CDOs."
Since collateralised loan obligations first appeared in the Euromarket in 1996, the CDO market has grown exponentially, but it suffered a heavy bout of downgrades and defaults after the underlying credit markets turned sour in 2000 and 2001.
As losses mounted in the portfolios of bonds, loans or credit default swaps underlying CDOs, the spotlight was turned on the structures themselves, and some investors questioned whether some of the loss-making instruments were quite what they had seemed at launch.
HSH had sued Barclays for $151m, which was the amount its predecessor bank LB Kiel had invested in Corvus Investments Ltd, a synthetic CDO issued in 2000.
Barclays Capital is not only the lead manager of the deal, but is also its asset manager — meaning that it is responsible for choosing which credits to buy and sell from the pool during the deal's life.
Corvus was part of a series of CDOs arranged by Barclays at that time, many of which invested extensively in other Barclays CDOs. And like many of these other deals, Corvus's credit quality deteriorated rapidly, especially after September 11, since it owned significant holdings of aircraft lease securitisations.
Between December 2002 and September 2003, Fitch (the only agency that rated the transaction) downgraded Corvus's senior tranches from AAA to BB and its lowest rated tranche from B to C.
During the case, HSH alleged that Barclays had mis-sold the bonds to it, overvalued assets in the CDO's portfolio and used its power as asset manager to benefit its own balance sheet, rather than the deal. Barclays denied all HSH's allegations.
HSH bought LB Kiel in June 2003. The suit was originally lodged in July 2003, but only became public in September 2004. Pre-trial hearings were held in November, and the trial itself was due to start next Monday in London's High Court.
In a joint statement the two companies said only: "The legal proceedings between Barclays Bank and HSH Nordbank AG have been resolved amicably. We look forward to continuing a normal business relationship."
The terms of the settlement are unknown. However, it is likely to cover not only the LB Kiel claim over Corvus, but $420m of investments that Hamburgische Landesbank, HSH Nordbank's other predecessor, made in Corvus and Nerva, another Barclays CDO. These claims were not included in the original suit.
BPI alleges mis-selling
In a statement describing its suit against Bank of America NA, Banc of America Securities Ltd and Helix Capital (Jersey) Ltd, BPI claimed that it had suffered Eu40m of losses on a series of BofA credit linked notes, including Helix Capital, issued in 2000 and 2001, in which it had invested Eu62m.
According to the statement, translated from the Italian: "BPI claims in fact that it was incorrectly led to buy securities with a risk profile higher than that declared by the seller, and at an excessive price with respect to their degree of riskiness. Furthermore, BPI claims to have suffered losses attributable to an incorrect management of the credit portfolios underlying the securities, in violation of English and Italian law."
BPI declined to comment further, while BofA also limited comment to a brief statement: "We have just heard about the lawsuit and will need time to review it, but plan to defend ourselves vigorously against the allegations."
No detailed statement of particulars of claim has yet been lodged at the High Court in London, but it is expected within days.
It is not clear which of BofA's Helix deals BPI bought, but the series of synthetic CDOs began in April 2001 with a Eu44m five year bullet note, referencing a Eu800m portfolio of 80 investment grade credits. The tranche was priced at 275bp over six month Euribor.
Paul van der Maas, European head of structured credit products at Bank of America in London, told EuroWeek in April 2001: "Our objective was to get people involved in this asset class with a view to selling future issues."
He explained that the purpose of the structure was to manage Bank of America's credit exposure.
The Eu44m tranche, originally rated triple-A by Fitch and Moody's, is now rated DD by Fitch.
Duty of care rules
Loiacono said that he believed many of the cases to come would rest on the interaction between English law, which governs most European CDO and derivative contracts, and laws in the countries where investors are based.
English law, under the FSA's Conduct of Business Sourcebook, allows for certain institutional investors in certain circumstances to be treated as "market counterparties", to whom companies providing investment services owe only contractual obligations.
Less sophisticated customers — institutional and retail — are accorded greater protection.
But "market counterparty" treatment is not available for securities that are actively marketed from the UK to many European countries, including Italy.
In these cases, according to the Committee of European Securities Regulators, the relationship should be one of an "investment firm" to a "professional customer" under the "professional regime".
In this regime the investment firm must act "honestly, fairly and professionally in accordance with the best interests of its customers and the integrity of the market". The burden of proof is on the investment firm to show its compliance.
"In Italy, the rules are more protective of the buyer," said Loiacono. "Under UK law, the seller is liable only in case of misrepresentation. In Italy, the seller must always be of good fait; there is a duty of care of the client, a duty to act in the best interests of the client".
According to Loiacono, cases from Spain, Germany, Greece, and Italy may be brought by banks, insurers and even charities. Only BPI's suit has been filed, so far.
