Carina: The 18-Notch Downgrade

You wondered what would happen when a CDO was forced to liquidate? Now you know:

The ratings on the most senior class of Carina CDO Ltd. were lowered to BB, two levels below investment grade, from AAA, while another AAA class was slashed 18 steps to CCC-minus. The chance of material losses to note holders is high, New York-based S&P said.

Carina is a CDO which was born in September 2006. When it failed an over-collateralization ratio test, the senior debt holders triggered their option to liquidate. S&P said the proceeds would be sold at "what will most assuredly be depressed prices".

You can be sure that the vultures are circling Carina already: this is the kind of event that distressed-debt investors live for. What's interesting is that S&P said that the AAA debt would only have been cut by two notches had the CDO not decided to liquidate: they clearly reckon that the structure is still reasonably sound. But if that was really the case, one would imagine that the senior debt holders would simply have tried to sell their CDO tranches in the secondary market, rather than liquidating the entire vehicle.