Investors in some older, poorly performing collateralized debt obligations are pushing to liquidate at least three high-yield bond CDOs, according to CDO pros familiar with their plans. If successful, they say it would appear to mark one of the first times a CDO has been dissolved. ZAIS Group, a manager of CDO squareds, is among the investors involved, says Denise Crowley, senior portfolio manager in Red Bank, N.J. She declined to name other participants or reveal the status of the talks.
The deals in question include Magnus, Mt. Washington and SCM Communications--all seasoned CDOs that were issued in the late 1990s and have each experienced sharp downgrades. The senior bonds of SCM Communications for example, which were issued at double-A, are now single-B plus. ZAIS and other investors apparently want to break up the deals because junk bonds have rallied to their tightest levels in years, and liquidating the CDO would allow them to take over and sell the bonds, say outside observers.
In general, breaking up a deal "makes sense where the underlying collateral is worth more than the CDO liabilities," says Richard Gugliada, head of the global CDO group at Standard & Poor's. He declines to comment on specific deals where it's being considered, but says it is definitely a growing trend. Although CDOs are designed to reflect the value of their underlying assets, analysts say CDO spreads have not tightened as much as junk spreads because of weaker liquidity and a lack of transparency in the CDO market. An analyst at one of the top CDO originators says the strategy makes particular sense now, as bonds appear to have peaked and investors would want to recover as much value as possible.
The effort is part of a wider trend of investor activism in the CDO market, in which underperforming managers are increasingly being replaced. A manager of CDOs says a break-up makes even more economic sense for distressed investors, including ZAIS. "Their basis is probably different than the original holders, so they have more of an incentive to press to liquidate," he notes, adding that investors who have held the notes since their inception would be less likely to want liquidation, because it would lock in steep losses.
Liquidation would be a blow to the managers of the deals, according to one analyst. "You want to keep a deal out there as long as possible because you're earning fees from it," he reasons, noting that even managers of poor-performing deals generate some revenue off the deals and have an incentive to keep them alive. Shenkman Capital Management is collateral manager for two of the CDOs in question. Mark Shenkman, president, declined to comment. CDO officials from Citigroup and Morgan Stanley, which brought these deals to market, either declined to comment or were unable to by press time.
One head of CDO origination at a large dealer firm says better transparency and analytics are helping dealers and investors more properly value the underlying assets of CDOs, and that this strategy couldn't have been implemented, say, a year ago. "People are trying to find value through distressed CDOs and it seems like a reasonable enough strategy."