Zais CDO bankruptcy language is in 78% of deals, says RBS

Royal Bank of Scotland structured credit strategist Justin Pauley writes in his most recent CLO Market Review that many CDOs (including CLOs) allow senior investors to file the deal into bankruptcy. Pauley examined ("endured" is the word he uses) 27 CDO indentures, and found that in the majority of deals it is only junior investors that are prevented from filing the vehicle into bankruptcy. This contradicts the common supposition that CDOs are bankruptcy remote because all noteholders agree at the outset not to use the bankruptcy courts.

Pauley says the language he found in 20 of the 27 deals is similar to that in the Zais Investment Grade VII CDO, which is the subject of an involuntary bankruptcy filing from its senior debt investors (see Mezz fights attempt to bankrupt bankruptcy remote CDO). The clause prevents the junior debt from causing the filing of a petition of bankruptcy against the issuer "for the benefit of the [senior] notes", but does not bind the senior class in the same way.

Awareness of this subtlety may increase the supply of paper from ABS CDO liquidations, says the report. Pauley notes that the Zais CDO owns $109 million of CLO collateral which would be sold if a liquidation goes ahead. But it will not lead to imminent CLO liquidations, since no standard cashflow CLO has ever triggered an event of default.