Asset managers of between seven and eight market-value CBOs have sent legal documents to investors requesting ratification of amendments to avoid early amortization events. The deals could go into early AM because they are coming dangerously close to breaching their minimum net-worth tests, which are calculated once per year.
"This is a legitimate fear," said one market-value CBO asset manager familiar with the amendments. "If a market-value CBO breaches its minimum net-worth test, it amortizes and liquidates its portfolio. This is not what we want in these bad markets."
Bain Capital's Sankaty market value CBOs reportedly have had all of their outstanding MV amendments approved on their older deals and will now rely more heavily on the O/C tests that drive these deals, said a rating agency official.
Each class of investor needs to agree to the amendments. However, debt investors may benefit from an early liquidation, because it is possible that they could capture more value in the assets than if they wait for recovery of the liquidated reference pools.
Said one market-value CDO debt investor, "I don't agree with moving minimum net-worth tests; when these triggers get close to breaching is when the managers start to take care of problems."
In order to entice the debt investors to go along with the amendments, which could cause a disastrous liquidation of assets to the detriment of the equity investors, the asset managers in some cases are putting between $2 million and $10 million more equity in these deals.
"This is a classic example of the battle between the equity and debt investors, which is a zero-sum game," said one CDO researcher.
However, the rating agencies appear in favor of the modification to the documentation since it would put them more in line with current deal standards, putting more emphasis on the O/C tests.
"Moving to a sliding scale minimum net-worth test essentially allows the minimum net worth to be calculated as a percentage of the actual capitalization rather than fully drawn capitalization," said one rating agency official.