Super-Senior CDO Investments

Some investors who purchased the "super-senior" portions of CDOs are beginning to take action to try and protect their investment. Traditionally, super-senior tranches are the safe portion of the CDO, usually safe enough to garner an AA or AAA rating. This comes in part, not just because the super-senior tranches are senior, thereby being the last to incur losses when the debt backing the CDO goes bad, but they are further protected since the senior tranche has now been broken into two tranches, with the super-senior tranche being the highest. Therefore, even if losses approach the senior portion of the CDO, which they have in some instance with the mortgage-backed CDOs, the super-senior investors are suppose to still be safe. Unfortunately, this has not been the case for all CDOs, causing investors in these securities to take action. Some investor groups are now using any power they have to seize control of the deals to make sure they receive their money first. What options do they have? The super-senior investors can either redirect cash flows until they are paid off (acceleration), or pursue what is called the "nuclear option", which involves immediate liquidation. Each are a difficult call since the redirection of cash flows may decrease or stop all together, while the nuclear option causes the securities to be sold at fire-sale prices, sometimes at 60 cents on the dollar. Nonetheless, many super-senior investors feel they have no other options considering that they often bought the highly rated debt as part of the "safe" investment portion of their portfolios, and were not expecting any losses or risk with these securities. The problem is widespread. Morgan Stanley research shows 4,485 downgrades this year alone for various CDOs, with over 4,000 of the downgrades related to CDOs of asset backed securities.