US CREDIT-Investors seek changes as CDO values plunge

By Karen Brettell

NEW YORK, Aug 14 (Reuters) - Investors in structured deals
backed by corporate credit derivatives are increasingly looking
to restructure the deals as spread weakness drives down their
market value.

Fears that market losses would spur mass unwinding of the
deals, in turn further widening credit spreads, have thus far
proven unfounded, as many investors hold on to the deals on the
belief that market spreads overstate their ultimate default
risks.

Synthetic collateralized debt obligations, which pay
investors leveraged returns from selling protection on a
portfolio of corporate credits, gained in popularity during
2005 and 2006 as tight credit spreads encouraged investors to
seek out higher returns.

As spreads gapped out, however, many of these deals have
suffered significant losses in market value.

"A valuation below $50 is quite possible, even if the
reference credit portfolio is relatively high in quality," said
Lehman Brothers analyst Gaurav Tejwani.

However, "in synthetic corporate CDOs the (current)
widening is more because of the systematic spread widening and
is not as big of a fundamental issue that these tranches will
be wiped out in the next year," he said.

The spread on the benchmark investment grade credit
derivative index has widened to 135 basis points from less than
10 basis points in June 2007.

Fears that losses in the deals would hit triggers leading
to their liquidation helped send spreads on the index screaming
over 200 basis points in March.

Instead of the feared mass unwind, however, some investors
have been seeking changes to help support their ratings and
mitigate exposures to the weakest credits.

"There has been increasing enquiry from investors asking
what they could do to restructure the trades so that the
ratings of their investments might be made more stable," said
Madhur Duggar, analyst at Barclays Capital in New York.

Downgrades of companies commonly included in the CDO
portfolios, such as bond insurers MBIA Inc (MBI.N) and Ambac
Financial Group (ABK.N), have pressured the ratings on many of
the deals.

Standard & Poor's cut 390 U.S. corporate investment grade
synthetic CDOs backed by corporate debt in the first half of
2008, compared with only 255 deals for the full year of 2007.

"Solutions have come in different forms and have included
trading out of names that are particularly troublesome from a
credit standpoint or adding subordination to a tranche by
increasing its duration and/or lowering its coupon," said
Barclays's Duggar.

"By and large the simplest solution people have had is to
inject cash into the transactions to build additional
subordination," he said.

HOLDING ON

With valuations on many deals likely to remain depressed
for at least the foreseeable future more investors in the deals
are likely to make changes to the deals, or in some cases
unwind them.

Mass unwinds, however, are considered unlikely absent a
dramatic regulatory or rating change.

"We think unwinds will be relatively sporadic barring
multiple corporate defaults, any regulatory or accounting
change or major change in rating agency assumptions," said
Lehman's Tejwani. "And none of those are imminent to the best
of our knowledge.

"Most of these tranches will return the investors' money
back unless corporate default rates are more severe than what
we experienced during the previous cycles," he said.

CDOs are designed to withstand some defaults, meaning a
significant increase over current expectations would be needed
to wipe out the investments.

"So far, investors have also been able to hold onto the
trades because even though the marks on these trades have been
fairly low they've still been able to say that the actual
portfolios haven't experienced material defaults," said
Barclays' Duggar.

"One risk to this scenario is that an uptick in defaults
changes market sentiment and expectations about future defaults
causing investors to become more uncomfortable with their
trades," he added.
(Editing by Leslie Adler)