Alesco Financial (AFN)

Alesco Financial's (AFN) CDO woes never seem to end. Today's blowup comes courtesy of ailing Alt-A lender IndyMac Bancorp (IMB), which announced (in addition to a worse-than-expected quarterly loss) that it would defer the interest payment on its trust preferred securities. AFN holds a portion of the equity interests in eight CDOs that include trust preferred securities issued by IMB.

The disclosure sent Alesco shares reeling and prompted the Company to issue a statement quantifying the impact of the IMB non-payment. AFN admitted that that IMB's deferral will trigger the over-collateralization tests in five of the eight CDOs for a period of time. Failing the O/C tests will cut Alesco off from the cash flow from these CDOs, although AFN will still record the interest income (as it is doing with the Kleros CDOs).

AFN claims it could maintain its current dividend stream despite the O/C test failures, but cautions that "[the Company] is reviewing a number of strategies for the company, including whether to continue to maintain its REIT qualification. Any change in strategy could impact the level of future dividend payments."

Perhaps Alesco can withstand one deferral, but if another IndyMac situation arises (and one has to believe it will), Alesco's CDO machine will overheat and crash.

Alesco announced today that it was declaring a Q2 dividend of $0.25 per common share. However, James McEntee, President and CEO of Alesco Financial, cautioned, "Our REIT taxable income to date supports the payment of a $0.25 dividend per share for the quarter. AFN is continuing to review strategic alternatives for the company, including whether to continue to maintain its REIT qualification. Any change in strategy or operating results could impact the level of future dividend payments."

With the Kleros CDOs moving closer and closer to liquidation, it is likely that Alesco will remain a REIT for 2008, but will convert to a publicly-traded partnership (PTP) for 2009 and beyond. Alesco's money-making bank and insurance TruPS portfolios are not qualifying REIT assets, and with the lowered spread available on RMBS (limited repo lines available makes it difficult to lever up RMBS to profitability), it makes sense that the Company will end its run as a REIT.