Banks buy crumbling CDOs to stem losses

By Al Yoon and Walden Siew - Analysis

NEW YORK (Reuters) - Some banks which have been forced to take huge valuation write downs on their stakes in mortgage related securities are now trying to squeeze out other investors to secure any remaining interest payments for themselves.

The junior investors in the collateralized debt obligations (CDOs) that hold such mortgage assets may be left with nothing as the banks try to lock in any remaining value.

CDO's are repackaged asset-backed securities that typically own a variety of debt, and are sold to investors in slices with different yields depending on the credit risk.

Banks, which through "super-senior" security rankings are deemed controlling investors, may increasingly force liquidations of CDOs which may leave junior investors high and dry, analysts said.

"If you are a triple-A holder, how do you get your money back?" said Jeff Given, a portfolio manager at John Hancock in Boston. Investment banks "may be buying so they own more of the securities to control the vote."

Banks ranging from Citigroup Inc (C.N), the largest U.S. bank, to Swiss bank UBS AG (UBSN.VX), are taking the biggest losses on CDO's and other "structured finance" vehicles, as rising defaults on U.S. home mortgages and falling house prices undermine their value.

Citigroup on Tuesday said it suffered a record fourth-quarter loss due to an $18.1 billion write-down, mostly due to CDO exposure.

Banks overall have announced about $90 billion in write-downs and losses due to defaults on U.S. home mortgage payments. More writedowns are expected, but banks' purchases of CDO assets also suggest they continue to see value in the downtrodden securities.

RATINGS DOWNGRADES FORCE CDO LIQUIDATIONS

Liquidations of some CDOs have become possible because credit ratings agencies have aggressively downgraded some of them, forcing 63 CDOs with par values of $70 billion into technical default.

Standard & Poor's said in January that it cut, or may cut, the credit ratings on more than $83 billion in CDOs tied to U.S. residential mortgages.

On Tuesday, S&P raised its assumptions on subprime mortgage losses in a move that may bring another wave of credit rating downgrades.

The scope for future liquidations is broad, with banks such as Merrill Lynch & Co. MER.N owning more than half of all "super-senior" CDO classes, according to JPMorgan Chase & Co research. Citigroup and Merrill Lynch spokespersons didn't return phone calls or declined to comment.

Last week market sources said UBS purchased 90 percent of the TABS 2006-5 CDO, which had an original size of $1.5 billion. Michael Barnes, a founder of TABS manager Tricadia CDO Management, did not return a call. A UBS spokesman declined to comment.

But defaults on CDOs have jumped after credit rating downgrades reduced projected levels of protection for senior bondholders, not because income streams from the CDO have ceased.