Not surprisingly, in light of the plethora of fallen angels, a number of accounts are trying to unload distressed investment-grade synthetic CDOs that are currently highly-rated, the segment most impacted by the credit trend.

According to one investor, four-year bullet maturity, highly rated IG synthetic CDO paper is being offered cheap.

Of course, this has all been escalated lately as WorldCom is a common credit in synthetic IG deals. According to Merrill Lynch's CDO research team, WorldCom is currently or was once held by at least 100 CDOs. Some exposures are as high as 3%. Fitch Ratings noted that one CDO they rate has a $70 million unfunded WorldCom position. However, overall average exposure to WorldCom in most CDOs is agreed to be about 1%, which by itself isn't enough to take down most deals. On the other hand, according to Fitch, which put 15 CDOs on watch negative for WorldCom exposure, the majority of those deals were already experiencing credit deterioration and this is likely the "straw that broke the camel's back," at least for the ratings on a handful of lower-rated tranches.

Merrill points out that it will be interesting to see whether collateral managers bought, sold or held their WorldCom holdings over the past few weeks. Of the 70 CDOs that Fitch rates which have exposure to WorldCom, a handful are market value CDOs and high-yield CBOs that picked up the name as it cheapened over the past few months. The late-June announcement by WorldCom regarding a $3.8 billion accounting discrepancy caused the bonds to drop from dollar prices in the high 30s to the mid-to-low teens.

The most direct impact of the announcement will be that more CDO's credit quality will deteriorate, leading them to fail their performance tests (overcollateralization tests, triple-C limit tests, weighted average rating factor tests, etc.), according to Merrill. This is especially pertinent for investment grade CDOs, since WorldCom's unsecured debt was rated single-A as recently as four months ago and investment-grade within the last month. The potential exists that other financially troubled technology companies could be forced into bankruptcy, further pressuring the CDO market.

While the re-pricing of the high yield market is painful for most outstanding CDOs, the higher yields may enable some collateral managers in the ramp-up stage or in the reinvestment stage to enhance the future performance of their portfolios by buying attractive securities at much wider spreads. WorldCom's woes have widened high yield spreads and improved the funding gap arbitrage, according to Merrill, which has a Lord, Abett & Co. HY CBO raising equity for a potential launch this summer.

The long-term corporate credit rating on WorldCom was lowered to CCC-' from B+' by Standard & Poors following the company's announcement that it intends to restate financial statements for 2001 and the first quarter of 2002 due to the overstatement of EBITDA by about $3.8 billion. Fitch downgraded WorldCom's long-term rating to CC' ratings watch negative on June 26.

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