The Curious Case of Lincoln Avenue -- A Structured Credit Medley

If you find this post complicated: it's the whole point. Thanks to the Lincoln Avenue deal, we are about to encounter in this post almost every contraption created in the gogo years of credit. In fact, it is so complicated that I doubt any rating agency or investment bank has the models and the infrastructure to properly analyze such deals. Of course, we could also say that confusing structured credit investors is the whole point as well!

So judge by yourself. And BTW, everything here is public data, you just need to google for "Lincoln Avenue CDO" and do some research on the Bloomberg terminal.

The Lincoln Avenue ABS CDO, issued in July 2006, has a rather eclectic collection of paper as collateral: other collateralized debt obligations (CDOs), some U.S. commercial mortgage-backed securities, and U.S. residential mortgage-backed securities. So it is in part a CDO-squared, a CDO of CDO.

The maturity of Lincoln Ave is nothing less than 40 years. Its senior tranche, the Class A-1 notes, was originally rated AAA by S&P and Aaa by Moody's; it had $1.094bn of notional. The next notes in subordination order is the A-2, with $77mm of face value; then $26mm of Class B notes, $21mm of Class C, and $19mm of Class D, "equity" or "first-loss" notes.

According to totalsecuritization.com, Lincoln Avenue ABS CDO had an "event of default" (EOD) as early as Sept 12, 2008. In fact, a majority of Lincoln Avenue's collateral has today a rating of just C (i.e., junk) by DBRS.

So not surprisingly, everyone seems to be trying to get rid of this stuff.

First, in December 2007, Barclay's repackaged $7.5mm of face value of Class C notes (ISIN: USG5490EAD07) of Lincoln Avenue, together with 9 other CDO securities, into $70MM "Principal Protected CDO Portfolio-Linked Notes" and into a $20MM so-called "Credit Linked Note Programme." Looking at the OM, it seems that these securities had ISIN XS0336216634, and were marketed mostly in Europe.

Then, recently, even the holder of the top of the capital structure of the Lincoln Avenue CDO, the holders of Class A-1 Notes, seems to try to swap the toxic asset away: DBRS announced today that it "has assigned a rating of BBB (low) to the total return swap (TRS) referencing Lincoln Avenue ABS CDO, Ltd.'s Class A-1 Notes, pursuant to the transaction documents dated April 28, 2009, with a current notional amount of $82,860,028." As an aside, DBRS indicates that "this rating is being provided at the request of the majority Class A-1 Noteholder." I.e., their client is not the CDO, but indeed an investor in the CDO's top tranche -- the holder trying to swap its position away.

Now, listen to this: "The TRS benefits from approximately 92.2% subordination" from the Class A-1 Notes and from a "commitment letter" (a credit enhancement). So, even with 92.2% of subordination and the credit enhancement, the TRS could barely get an investment-grade rating? Personally, I consider ratings in structured finance have lost all and any credibility. (In fact, I find suspicious the sheer fact that the TRS barely passed IG.) But the low rating given the subordination and the commitment letter shows how toxic the collateral and the structure is. In other words, if the TRS on the A-1 notes are BBBL-quality, the Barclay's note probably couldn't receive a rating at all.