Did Merrill's CDO Contagion Spread to Cohen & Company?

An interesting (and free) article from the Wall Street Journal reveals that Merrill's (MER) whopping $7.9 billion write-down might have had its seeds sown as early as 2003 -- and a familiar name in the mortgage REIT world, Cohen & Company, might have been its victim.

The article reveals that in the 18 months after Chris Ricciardi's early 2006 arrival from Merrill, Cohen's assets under management swelled to more than $40 billion from $10 billion. Mostly in conjunction with Merrill as underwriter, Cohen formed 25 new CDOs valued at $23 billion, most of which contained subprime mortgages.

Many of these CDOs were issued through Cohen & Company's managed REIT - Alesco Financial (AFN). In addition, a large number of CDOs were also issued through another Cohen-controlled entity, Taberna Realty Finance. Late in 2006, however, as the cracks in the mortgage finance indsutry became much more visible, Cohen & Co. transferred its Taberna investment to another publicly-traded entity, RAIT Financial Trust (RAS) - a company that conveniently happens to be run by Betsy Cohen.

The Cohen CDO machine hit a wall earlier in the summer. The Taberna CDOs acquired by RAIT have been downgraded and produced at least one default -- when American Home Mortgage's (AHMIQ.PK) bankruptcy wiped away the value of RAIT's investment in American Home's trust preferred securities. The default amounted to net equity exposure of approximately $95 million, or $1.56 per share of RAIT's book value. Meanwhile, Alesco admitted in September that two of its CDO issuances were failing overcollateralization tests, which meant that cash flow to the subordinated tranches held by Alesco would be cut off.

Shares of RAIT Financial Trust have fallen 76% since hitting a high of $38.25 in February. Shares of Alesco Financial have fallen 62.5% in the same time frame.

Disclosure: Author is long RAS