NEW YORK - As the public markets continue to stumble - and with war swiftly moving into the picture - investors are looking for revenue generating havens. That said, interest in alternative financing structures has increased, but it remains unclear how much of an appetite an expanding investor audience really has for instruments as complex as CDOs.
Several factors converged on the CDO market last year, including the drive by deal underwriters towards more transparency, i.e., the posting of modeling information on third-party analytics providers by the likes of Salomon Smith Barney, Goldman Sachs and Morgan Stanley. Privately, bankers have noted the increased sophistication of CDO investors, both with the technology involved and by their expressed interest in floating new types of vehicles during distressed economic times. But these features pertain primarily to existing market mavens.
Signs that others investors may be contemplating investments in CDOs have cropped up in road show attendance, according to sources - albeit there haven't exactly been many with just one month tucked under 2003's belt. Yet just last week private placement market players gathered at the Institute for International Research's annual industry conference in New York, and one panel presentation focused on strategies for maximizing collaterized debt and loan obligations.
Despite the topic's late afternoon spot on the agenda, most attendees remained in their seats for Joseph Lorusso, founder and managing director of Structured Finance Advisors and Neil McPherson, head of asset-backed research at Credit Suisse First Boston. The two were joined by Elizabeth Russotto, senior director, Fitch Ratings.
Of no fault of their own, the panel didn't exactly get off on the right foot. The trio delved into horror-show like statistics from 2002, the year of record-breaking downgrades. While 261 tranches were downgraded by Fitch last year, just 19 were upgraded, for example. However, noted Fitch's Russotto, in 2001 not a single CDO debt tranche was upgraded.
"The majority of downgrades were the direct result of poor performance in the high yield bond market...and in the investment grade CDO sector poor performance was due to fallen angels," she explained.
The level of pencil pushing during the panel discussion gave further credence to the belief new investors are looking at CDOs. Note takers were quite active in jotting down factors listed as last year's culprits; those "sinister" CDO vintages from 1997 through 1999; inflexible swap schedules that curtailed managers' abilities to, well, effectively manage; and unusually high coupons which prevented managers from buying up to improve weighted average credit quality in a vehicle.
One investor in attendance, hailing from a mezzanine fund, stated his interest in this market was the appearance that CDOs are long-term investments. "From what I understand, these are 12-year instruments at a minimum," he said. "That's very appealing right now...as an investor in privates we look more to buy-and-hold instruments."
Other audience members were particularly keen in hearing from Lorusso, as Structured Finance Advisors has issued three ABS CDOs since 2000.
"We've come full circle, that's for sure," said Lorusso, explaining how launching each CDO differed greatly due to market environment year to year. When the firm began shopping around its first CDO, "it was basically a club deal, we approached our known investors," he said. Launching a CDO in 2001 proved much easier, as the atmosphere was "you couldn't go wrong," Lorusso continued, "but last year we were starting to see cracks in that." Pressing onward however, the firm is shopping around a fourth CDO, this time going to investors and talking to advisory boards. "That's the state of the affairs today," he said.
McPherson forecasts an increase in structured finance CDOs backed by mortgage related product 2003.
"Amazingly, home equity had a good year, outside of manufactured housing," McPherson said. "There's an ample supply available for the creation of structured finance CDOs," he said. Such prospects look quite compelling considering CSFB believes the worst of the recession has already occurred, even in the event of war, and that employment figures will peak at 6.1% to 6.2%.
Investment grade synthetics are also expected to capture interest, "but there seems to be spread tightening with single-A's and triple-B's, so I'm not sure it will be as big in the coming timeframe," said McPherson. Currently, he continued, spreads appear good in mezzanine tranches. Overall, CSFB forecasts $50 billion in CDO issuance in 2003.
A CDO market that can cycle in a structured finance trend was appealing to at least one potential investor.
"We would look at straight structured finance CDOs, as I agree with McPherson's contention that in the first three years you're unlikely to see a default," said one source from an insurance firm.
But if this audience of private placement players could act as the litmus test for new interest in the CDO market, collateral managers and investment banks are strongly encouraged not to add staffers to meet the demand just yet. Just five attendees raised their hands when asked by the panel who, in the room, currently purchased CDOs.