Collateralized Debt Obligations (CDO)
In the News
Lawsuits Linked to Subprime Damage Expected Next Year
By Nicholas RummellDecember 19, 2007
There's plenty of blame to go around in the current credit crisis, but owners of mortgage-backed securities looking for someone to pin the mess on may be going after one target in particular: Wall Street firms that packaged the securities into collateralized debt obligations.
This week, charities and municipal councils in Australia sued a subsidiary of Lehman Brothers over risky CDOs that were sold to the councils in violation of investment guidelines. Read More...
Merrill Gets Slapped With CDO Lawsuit
By Riley McDermidDecember 5, 2007
A class action lawsuit has been filed in U.S. District Court in Manhattan alleging that Merrill Lynch and Co. Inc. violated securities laws by inadequately informing investors about the risks involved in its exposure to collateralized debt obligation.
The suit cites a Wall Street Journal article that appeared on Nov. 2 that alleged Merrill may have created certain hedge fund deals in an effort to avoid or delay reporting its total CDO losses. The suit was filed by Merrill investor Gary Kosseff and other unnamed investors on Dec. 4. The class action status could apply to all investors who purchased Merrill stock from Nov. 3, 2006, to Nov. 2, 2007. Read More...
FBI Investigating 14 Corporations over Possible Fraud in Subprime Lending
By Kevin DrawbaughTue Jan 29, 2007
The FBI said it is investigating 14 corporations over possible accounting fraud and insider trading violations in a crackdown on subprime lending. The companies were not named.
The agency said they include developers, lenders and financiers that securitized ordinary home loans into exotic investment instruments, as well as banks that held them.
SEC eyes disclosure in subprime probes
By Rachelle YounglaiFeb 9, 2007
WASHINGTON (Reuters) - The Securities and Exchange Commission is investigating how banks, credit rating firms and lenders valued and disclosed complex mortgage-backed securities that ultimately led to the subprime crisis, a top agency enforcer said on Saturday.
"The big question is, who knew what when, and what did they disclose to the marketplace?" said Cheryl Scarboro, an associate director in the SEC's enforcement division in charge of the subprime working group. The SEC has opened about three dozen investigations into firms and individuals involved in the subprime mortgage market. The investor protection agency has not named any names. But Morgan Stanley (MS.N) and Merrill Lynch (MER.N) are some of the firms in the financial services industry that have disclosed that government investigators are seeking information about their subprime activities.
Credit Suisse catches subprime virus
By FRANK JORDANS, Associated Press WriterGENEVA - After seeming to have skirted the worst of the mortgage issues plaguing the financial sector, Credit Suisse revealed Tuesday that it had suspended a "handful" of traders for overvaluing assets and would take a $1 billion hit to its first-quarter results.
Switzerland's second-largest bank said it would still post a profit for the period, but the mispricing of asset-backed securities led to an overvaluation of about $2.85 billion.
Merrill chief of U.S. CDO research resigns: sources
Jan 28, 2008NEW YORK (Reuters) - Lang Gibson, a member of the team that helped Merrill Lynch & Co Inc (MER.N: Quote, Profile, Research) become the No. 1 issuer of collateralized debt obligations, has resigned, people familiar with the situation said, as a CDO-related credit implosion roils banks worldwide. Gibson, who headed Merrill's U.S. CDO research, resigned last week, people familiar with the situation said on Monday. Merrill Lynch declined comment. Gibson's research went to Merrill clients interested in structured credit finance investments.
Under Chris Ricciardi, then head of global structured credit products, Merrill Lynch became the top CDO issuer, only to see the strategy backfire when the market for CDOs dried up. Rising defaults on risky U.S. subprime mortgages, which were used as collateral for many CDO issues, accelerated the CDO market's tailspin.
Most financial guarantors have been very active in the CDO (collateralized debt obligation) and CDS (credit default swap) markets, accumulating approximately $210 billion of net exposure by the third quarter of 2002. The growth in this business has been very rapid, with CDO/CDS exposure now representing more than 15% of the financial guaranty industry's net par outstanding.
Corporate debts are generally the reference or underlying assets of CDOs and CDS and most of the guarantors' exposure to corporate credits is through their CDO/CDS book. Their investment portfolio is composed primarily of government, agency and municipal securities. The large volume of corporate defaults over the last few years has hurt many CDO/CDS transactions, resulting in significant downgrades and losses in the overall CDO market.
However, the nature of the guarantors' exposure to CDO/CDS, generally highly rated senior exposures, has for the most part sheltered the companies from significant credit deterioration of the underlying exposures and from actual credit losses. The guarantors' CDO/CDS portfolios remain highly rated with approximately 88% of their exposures rated Aa or better.
The corporate credit environment remains weak with defaults, peaking to levels not seen since 1991. Even if corporate default rates continue to decrease in the near future, the current high level of defaults implies further deterioration of the portfolios underlying the financial guarantors' CDO/CDS exposure. This may result in further downgrades of some transactions and could generate some additional losses for the financial guarantors, which could reduce the guarantors' financial flexibility. To date, FSA is the only financial guarantor to have reported meaningful losses due to its CDO/CDS portfolio.
The volume of CDO/CDS transactions entered into by the financial guaranty industry is expected to decrease in the future. This will likely force the guarantors to refocus their growth plans on more traditional businesses and other new opportunities, which could translate into more competitive pressures within traditional sectors.
Rating Downgrades per Initial Rating and Origination Year 1 (% of net par outstanding)| 1996-97 | 1998 | 1999 | 2000 | 2001 | 1997-2001 | |
|---|---|---|---|---|---|---|
| Aaa | -- | 12.6% | 29.2% | 15.5% | 5.4% | 11.0% |
| Aa1 | -- | -- | 93.4% | -- | -- | 13.8% |
| Aa2 | 11.0% | 26.3% | 41.4% | 35.2% | -- | 24.5% |
| Aa3 | -- | 72.0% | 68.0% | 14.7% | 3.7% | 27.0% |
| A1 | -- | -- | 17.0% | 32.8% | 12.7% | 22.9% |
| A2 | -- | 38.6% | 12.3% | -- | -- | 8.3% |
| A3 | 100.0% | 88.8% | 78.0% | 16.9% | -- | 48.0% |
| Baa1 | 20.9% | 19.8% | -- | 42.8% | -- | 21.4% |
| Baa2 | 50.7% | -- | -- | 100.0% | -- | 32.9% |
| Baa3 | 33.8% | -- | 100.0% | -- | -- | 24.8% |
| Aaa-Baa3 | 33.7% | 28.8% | 34.4% | 18.4% | 5.0% | 10.3% |
|
1. Data based on guarantors' internal ratings; Rating data as of 3q2002. See footnotes 2-4 for examples of how to interpret this chart. 2. Implies 26.3% of net part outstanding of all transactions originated in 1998 with a Aa2 rating has been downgraded 3. Implies 8.3% of net par outstanding of all transactions originated at A2 level between 1996-2001 has been downgraded 4. Implies 28.8% of net par outstanding of all transactions originated in 1998 has been downgraded | ||||||
eMag Can Help
eMag Solutions offers a full spectrum of professional consultants and services designed to address the ongoing legal concerns around CDO, subprime mortgage, and structured finance markets.
Recent news headlines reflect that the FBI is investigating 14 multi-national corporations over possible fraud in subprime lending, as well as Securities and Exchange Commission investigations around how banks, credit rating firms and lenders valued and disclosed complex mortgage-backed securities that ultimately led to the subprime crisis.
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