Alesco Financial's (AFN) conference call was dominated by questions about the Company's structure going forward, particularly after AFN disclosed that it may struggle to remain a REIT if two or more of its Kleros CDOs are forced into liquidation. I first wondered about this issue back in November, but since then, the issue has heated up further.
Alesco's qualifying real estate investments are mostly tied up in their consolidated Kleros CDOs, which have all failed overcollateralization tests and are no longer pumping cash flow into Alesco. However, AFN is still allowed to recognize qualifying REIT income from these CDOs despite the events of default that have diverted cash flow. Because of AFN's heavy investment in non-qualifying REIT assets, it just narrowly satisfies the REIT qualification tests each quarter.
Five of Alesco's Kleros CDOs have actually technically experienced an event of default (per S&P), so the CDO noteholders have the option to liquidate these transactions. However, Alesco only consolidates Kleros I, II, III, and IV. Although liquidations are only opted for about 25% of the time, just two liquidations could cause Alesco could fail its REIT asset tests at the end of this quarter.
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