Despite growing liquidity in collateralized debt obligation equity, determining its value in the secondary market remains tricky. Recent bids for a $3 million chunk of distressed mezzanine debt, seen as the equivalent of equity, were as far apart as 25 points, said one CDO trader. “Knowing the deal’s cash flow waterfall is a very important factor in determining the value of CDO mezz and equity,” he commented.
The difference in bids is especially wide in CDOs backed by distressed corporate bonds. However, the difference is generally less than 10 points. Investors must take care to scrutinize payment streams and not assume one deal has the same waterfall as another. “It’s still not a screen-based product,” the trader said, referring to the fact the product is still complex to trade.