Tuesday, September 22, 2009

Liquidation of CDOs aids banks

Posted in the Financial Times by Aline van Duyn:

Billions of dollars’ worth of the complex securities at the heart of the financial crisis are being liquidated, enabling banks, insurance companies and other investors to clear toxic assets from their books.

Market participants say the unwinding is occurring in the market for collateralised debt obligations (CDOs), complex securities backed by the payments on mortgages, corporate loans and other debt.

Hundreds of billions of dollars of CDOs have defaulted, but the structures can only be liquidated if the underlying collateral can be sold. In recent weeks, more investors have been buying the underlying assets at deep discounts, leading to increased trade and boosting prices for some existing CDOs.

“There has been a significant increase in the amount of CDO liquidations,” said Vishwanath Tirupattur, analyst at Morgan Stanley. “The rally across asset classes has given investors an incentive to liquidate.”

CDOs were one of the main vehicles through which risky US mortgages were repackaged and sold to investors around the world. Much of their value was wiped out amid a wave of defaults on subprime mortgages. The inability to sell or unwind complex securities such as CDOs was one of the prime problems of the financial crisis. Now, the option to sell these so-called toxic assets is re-emerging. “For a long time it may have made sense for investors to liquidate CDOs, but this was not possible when there was no market for the underlying collateral,” said Ed O’Connell, partner at Jones Day.

The recent rally has been particularly marked for CDOs backed by corporate bonds and loans. Of the more than $500bn of CDOs backed by asset-backed securities sold in the boom years, $350bn have already experienced an “event of default”.

Once that happens, the holders of the top tranches, those once rated triple A, can opt to liquidate the CDO. This involves selling off the collateral. CDOs backed by corporate loans are now trading at levels last seen nearly a year ago, shortly after the bankruptcy of Lehman Brothers. Morgan Stanley estimates about $123bn of these defaulted CDOs have been liquidated.

No comments: