Fidelity Affiliate Rocked by CDO Problems
The financial earthquake known as subprime continues to wreak havoc - this time, it’s mutual fund giant Fidelity Investments feeling the pain.
In July 2007, a Fidelity affiliate, Ballyrock Investment Advisors LLC, issued $517 million worth of debt backed by risky subprime mortgages and other related loans. At first, the deal - known as collateralized debt obligations, or CDOs - received triple-A ratings; today, some of the debt is worth 15 cents on the dollar, according to several analysts.
Fidelity created Ballyrock Investment Advisors in 2002 to develop and manage collateralized debt obligations sold to institutional clients. In the beginning, the subsidiary avoided risky mortgages - that is until last summer.
Things went downhill quickly for the Ballyrock CDO. When the subprime mortgage debacle hit full force and a rush of homeowners began defaulting on the underlying home loans, Standard & Poor’s promptly cut the grade on some of the CDO’s securities from AAA to junk.
Moody’s Investors Service later followed S & P’s lead, slashing the ratings on various slices of the CDO and putting investors on notice that another downgrade may follow.
Apparently it is so bad that a $26.25 million tranche of the CDO has plummeted to only slightly above being considered a default risk. A recent article in the Boston Business Journal reports that another $150 million senior tranche of the CDO was cut from Moody’s top Aaa rating to just above junk status.
Taking a Fall
Problems with CDOs have rocked the financial world over the past year, taking a severe toll on some of Wall Street’s biggest players and causing tens of billions of dollars in write-downs. Earlier this month, the Wall Street Journal reported that Merrill Lynch  alone had more than $30 billion in write-downs since last October, most of which stemmed from the fallout of the subprime and CDO crisis.
The concept of CDOs has been around since the 1980s. A CDO is a structured debt vehicle that repackages the income from a pool of bonds, derivatives or other investments. For example, a mortgage CDO might own pieces of hundreds of bonds, with each piece containing thousands of individual mortgages.
Investors - including pensions, insurance companies, mutual funds and hedge funds - acquire slices of a CDO, receiving a fixed-rate of interest, similar to a bond, in return. The slices of a CDO are called tranches, and divided into various levels of risk, with losses applied in reverse order of seniority.
The highest-rated tranches are often referred to as super-senior tranches; investors at this level receive their payments before owners of the riskier lower layers. The lowest-rated tranche in a CDO provides the highest returns but assumes the greatest amount of risk.
It wasn’t until the subprime mortgage market went haywire that problems with CDOs began to surface. Much of the furor is around the fact that credit-ratings firms ranked the products much safer than they actually were. Moreover, the complexity of CDOs makes it difficult for investors to determine what they’ve actually bought and the true value of their investments.
These are the kinds of surprises that have investors up in arms - and heading to court. Shareholders and investors want answers from the sellers of CDOs as to why the risks associated with the product were never fully disclosed in the first place.
Institutional investors want answers, as well. On February 24, 2008, the German bank HSH-Nordbank AG announced that it intends to file a lawsuit against Swiss bank UBS in New York based on losses it incurred from its $500 million investment in a CDO called “North Street 2002-4.” The bank alleges that UBS made riskier investments than the bank was aware of or would have permitted.
Problems relating to investments in CDOs may well produce the next big wave of subprime lawsuits in the months ahead. Equally troubling is the fact that the owners of CDOs, including investment banks, hedge funds, insurance companies and pension funds, likely face even more write downs on mortgage investments beyond the billions they have already written off. For consumers and businesses, this means the availability of credit will be stretched tighter than it already is.
Our affiliation of lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.
