Distressed debt players are buzzing about the possibility of large asset sales on collateralized loan obligations rated by Moody's Investors Service in 1997 and 1998, but many market players say it is a false alarm as the rating agency has worked with managers to incorporate more flexible outlines on indentures. In deals rated by Moody's in 1997 and 1998 there is a provision in most deals that calls for CLO managers to sell off defaulted securities after one year. That provision is designed to prevent a drag on the deal created by the lag between recoveries and note payments. New distressed debt funds are popping up with the expectation of scooping up defaulted credits cheap relative to credit quality, cashing in on good recovery levels. "Distressed shops can low ball them [CDO managers] when there's more inherent value," said one portfolio manager of the much talked about scenario.
But CDO specialists hushed vulture enthusiasm and said that big asset sales haven't been seen yet and that many managers who have potentially troubled deals have gotten permission from investors to seek amendments to the original indentures--something to which Moody's has been responsive. "There's a lot of noise about this, but there's more smoke than fire," said a banker in CLO structuring at a major firm, explaining that Moody's has been willing to extend recovery periods on deals once approval is met by a CLO's investors.
In addition, market players said Moody's has become increasingly flexible with time periods. "I haven't heard of any liquidations, but managers are having trouble getting fees and cash flow to the equity," said one manager of deals currently under pressure. "We've had several deals where managers have gone to noteholders and asked for a reprieve or carve-out," explained Gus Harris, a managing director in the CDO group at Moody's. Harris makes the distinction that a change in the recovery assumption has come by way of manager request rather than a modeling overhaul by Moody's. "On newer deals a lag on recovery rates is in the modeling. If the model assumes immediate recovery, we ask for quick liquidation," said Harris.
"When these deals were done loans always hovered between 95-100," said one manager explaining a divide between the current market and structures from three or four years ago that presumed lower default rates, lower volatility, and higher recovery levels.