S&P; slashes State Street CDO rating

Standard & Poor’s said Thursday that a collateralized debt obligation, or CDO, managed by State Street Corp. began liquidating its assets, prompting the ratings firm to slash the investment vehicle’s credit grades as much as 18 levels.

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 the first CDO to begin unwinding after a slump in the creditworthiness of the underlying assets, S&P; said. Thirteen others have informed S&P; of an event of default, a precursor to liquidation.

CDOs package asset-backed securities -- such as bonds backed by sub-prime mortgages -- and resell them in pieces to investors.

The investment vehicles were wildly popular with institutional investors in recent years because they promised healthy returns with seemingly low risk. But the value of many CDOs has plummeted as mortgage defaults have soared.

Now, a widespread fire sale of securities by CDOs could further exacerbate declines in sub-prime-mortgage bonds, analysts warn.

Carina was originally a $1.5-billion CDO issued in September 2006, according to data compiled by Bloomberg News. Carolyn Cichon, a spokeswoman for State Street, didn’t immediately return a call for comment.

Senior note holders of the CDO decided to liquidate, S&P; said. The firm didn’t identify the senior investors.

The securities will be sold at “what will most assuredly be depressed prices,” S&P; said.

Investors already were concerned about forced asset sales by structured investment vehicles, or SIVs, which own about $300 billion of securities and have dumped more than $75 billion worth after being unable to finance themselves.

More than $350 billion of CDOs comprising asset-backed securities might become “distressed” because of credit-rating downgrades, Morgan Stanley said in a report Thursday.

“The pace of downgrades will pick up significantly over the next few weeks,” wrote analysts led by Vishwanath Tirupattur in New York. “Given the degree of market dislocations and the potential size of the market, there is clearly an opportunity for attentive investors.”