Feb. 5 (Bloomberg) -- Buying and selling of collateralized debt obligations based on mortgage bonds, high-yield loans or preferred shares has ground to a near-halt, traders said at the securitization industry's largest conference.

``We're definitely in a period of very low liquidity at the moment, which has actually been dropping precipitously in the last few weeks,'' Ross Heller, an executive director at JPMorgan Securities Inc., said yesterday during a panel discussion at the American Securitization Forum's annual conference in Las Vegas. ``It's a challenging time.''

The slowdown of the more than $2 trillion CDO market follows record downgrades in mortgage-linked securities last year. Some AAA rated debt lost all its value. CDOs, which have fueled unprecedented bank writedowns since mid-2007, repackage assets into new securities with varying risks.

Lighter trading volumes for asset-backed bonds and larger- than-typical differences between the prices at which they can be bought and sold have made valuing holdings difficult and dissuaded investors from purchasing the debt, said Sanjeev Handa, head of global public markets at TIAA-CREF.

Demand for new CDOs has stalled, with just one created in the U.S. so far this year, according to JPMorgan. The creation of CDOs dipped about 10 percent last year to $494.7 billion, according to the company. The figures include only issuance for which investor money was collected upfront.

Fitch Warning

Fitch Ratings today said it may downgrade the $220 billion of CDOs it assesses that are based on corporate securities. The New York-based company said it may lower the notes by as much as five levels after failing to accurately assess the risk of debt that packages other assets.

More than 60 ``opportunity'' funds have been created to take advantage of a plunge in prices for mortgage assets, said Carlos Mendez, a senior managing director at Institutional Credit Partners LLC.

Along with insurers, they're among the limited number of buyers of existing mortgage-linked CDOs, Mendez and Heller said.

Merrill Lynch & Co., the New York-based securities firm with a record loss last year amid writedowns on the most-senior AAA pieces of mortgage CDOs it underwrote, ``has been actively talking to people'' about purchasing its super-seniors, said Brian Carosielli, a managing director.

Investors with experience with residential-mortgage assets have been buyers, paying in the ``mid-teens to low 30'' cents on the dollar for the senior-most, or super-senior, classes of CDOs comprised of low-rated asset-backed bonds, he said.

Cutting Back

Merrill, the world's largest brokerage, last week said in an e-mailed statement it will cut back on underwriting new structured finance securities and CDOs ``for the foreseeable future.''

Carosielli and Mendez said they thought that trading of mortgage-linked CDOs has picked up a bit this year. So-called collateralized loan obligations, or CLOs, are ``definitely more illiquid'' in recent weeks than in the past, Carosielli said.

Some ``macro'' hedge funds without experience in the market have been CDO buyers, Mendez said.

``Everyone wants to be Paulson & Co.,'' he said, referring to the New York-based hedge fund that profited from the collapse of the U.S. subprime-mortgage market by branching into derivative bets against home-loan securities.

Some buyers have been seeking out specific mortgage-tied CDO classes that won't ever be offering payments to investors again, said Richard Rizzo, a director at Deutsche Bank AG.

Credit-Default Swaps

Those investors previously bet the classes would default by using derivatives called credit-default swaps. By buying the classes, they want to collect their windfalls sooner, as well as end the regular default-protection payments they owe, which may stretch on for more than a decade, he said.

Under about half of the swap contracts, Rizzo said, they can collect their windfalls sooner by delivering the class after a steep-enough downgrade to the bank that's taken their wager. The bank, which doesn't want to own the class, could then sell it to a similar investor.

``I've traded one bond that's worthless eight times this year,'' Rizzo said. ``So it's like, `How many times can I trade the same bond that's worthless for five cents?' It is kind of funny.''

Holding Back

About half of the more than 200 investors who JPMorgan analysts recently surveyed expected the CLO market to re-start in 2008, with a third thinking it won't come back until next year. About 80 percent said they plan to buy more CLOs. Thirty-four percent are mainly holding back because of ``spread instability,'' 24 percent cited ``headline instability,'' and 19 percent cited ``senior management concerns.''

Buyers want super-seniors from mortgage CDOs whose contracts allow owners of the classes to collect all payments from their collateral if downgrades on holdings exceed certain levels, Merrill's Carosielli said. They're also studying how much debt in the deals is either from non-subprime securities or bonds backed by loans to borrowers with poor credit created earlier than 2006, he said.

Some investors even want pieces of mortgage CDOs that are soon expected to either liquidate at losses for most holders or stop making payments to the classes they're buying, as a result of collateral downgrades, Heller said. That's because buyers can receive interest payments that are large relative to their investments until then, he said.

``To some extent, you're trying to predict what the rating agencies are going to do next,'' Heller said. ``And they're wildly unpredictable.''

To contact the reporter on this story: Jody Shenn in Las Vegas at jshenn@bloomberg.net

Last Updated: February 5, 2008 15:09 EST