Many investor suits on CDOs may follow HSH case

February 25, 2008
By Jane Baird

LONDON, Feb 25 (Reuters) – HSH Nordbank’s [HSH.UL] decision to sue Swiss bank UBS this week may be the vanguard of many investor lawsuits against banks over investments in collateralised debt obligations (CDOs) that have gone sour.

The German state-controlled bank said on Sunday it would start legal proceedings against UBS (UBSN.VX: Quote, Profile, Research) to recover losses on a $500 million investment in a CDO made in 2002.

“UBS appears to have condoned actions which benefited only itself, at the expense of its clients,” the regional bank alleged in a news release. It sued Barclays (BARC.L: Quote, Profile, Research) in a similar dispute in 2004.

HSH Nordbank’s representatives did not respond to requests to provide more detail on what those UBS actions were, saying only that the bank would file a legal claim in New York by the end of the month.

“What the actual complaint is, we won’t know until it comes out in black and white,” said Tom Jenkins, an analyst at Royal Bank of Scotland, in an interview. “The question focusses on how the CDO was managed? Did UBS put assets it didn’t want into this structure?”

This case “could pave the way for many more suits against it (UBS) and others,” he wrote in a note to investors. “We’ve been saying to our investor base to expect to see more regulation, more litigation,” he said.

UBS has declined to comment on the case.

At least two U.S. law firms earlier this month said they were investigating CDO sales by banks and asked investors to contact them. Both firms named UBS, and one mentioned Merrill Lynch ML.N, as well.


There is little that appears to distinguish the CDO named in the HSH Nordbank statement — North Street Referenced Linked Notes 2002-4 — from a number of other CDOs in the market.

It is listed on the Irish Stock Exchange, whose Web site shows listings of at least eight other North Street deals.

It was created in 2002 with a mixed portfolio that was designed to start at 70 percent corporate credits and move to 70 percent asset-backed securities, commercial mortgage-backed securities and real estate investment trust securities, according to report by Fitch Ratings.

A CDO is a portfolio of credit risks that has been divided into tranches, or slices. At the bottom, the riskiest tranche is exposed to the first few percent of losses from any credit in the pool. At the top, the AAA-rated tranche loses only after the lower tranches have gone under.

The original ratings on the six tranches of the $574 million North Street 2002-4 ranged from BB+ at the bottom to AAA at the top. Landesbank Schleswig-Holstein, a predecessor of HSH, bought the top four tranches.

On Nov. 12, 2007, Fitch downgraded this deal along with 83 other CDOs totalling more than $37 billion. It cited “increased probabilities of default with respect to recent vintage subprime residential mortgage-backed securities”.

The ratings of North Street 2002-4 fell to a junk CC at the bottom and A- at the top. Although the six-notch downgrade of the top tranche was steep, it did not stand out among the 84 deals.

HSH said it would claim that UBS’s management of North Street 2002-4 was in breach of the contract and that “substitutions were made solely for the benefit of UBS” and contrary to HSH’s interests.

“After repeated attempts to discuss our concerns with senior management at UBS, we find that, with regret, we have no alternative but to commence legal proceedings,” HSH said in a statement.

In an earlier case, HSH Nordbank sued British bank Barclays over a $151 million investment in a CDO it bought in 2000 based on a portfolio of asset-backed securities. It ended the case by accepting a settlement for an unspecified amount.

German sources said at the time that HSH had made repeated attempts to ask Barclays Capital why it began putting aircraft risk into the portfolio after the Sept. 11, 2001 attacks, which hurt the airline industry.

Earlier this month, the Seattle office of law firm Hagens Berman Sobol Shapiro said it was investigating whether UBS had fairly disclosed the risks of CDOs to municipalities and other investors.

The New York office of law firm Klayman & Toskes separately said it was investigating “how Merrill Lynch and UBS marketed their CDO products and whether the brokerage firms properly disclosed the risks of the products to its investors”.

Last month in one case, Merrill Lynch paid $13.9 million to the city of Springfield, Mass., which lost money on a CDO. A spokesman for the bank said the city had not expressly approved the purchase of the securities. (Editing by Jason Neely)

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