CDOs stand as "about the only market with spreads at or near all-time tights," according to a JPMorgan Securities report. "This performance cannot continue indefinitely," analysts wrote.

Spreads on new-issue CDOs priced in April didn't budge, except for one to two basis points of widening seen in investment-grade synthetic CDOs last week, added JPMorgan analysts.

"We are most concerned about the senior portion of the CDO capital structure, where demand appears somewhat weaker from total return and real money buyers. Since triple-A outstandings are so much larger than mezzanine notes, if selling gains momentum it may be difficult for the market to absorb the paper," they argued.

For example, the weighted average of triple-A rated tranches of structured finance CDOs have sat at 32 basis points over Libor since late March, and have compressed seven basis points since year-end 2004. Nearly all other collateral credit spreads have begun widening from historical tights in early 2005.

"Spreads are so tight, it is hard to honestly look anyone in the eye and say they are getting value in the market," said Mark Adelson, director and head of structured finance research at Nomura Securities.

Adelson added that despite difficulties in constructing classic arbitrage CDOs when spreads on underlying assets are too tight, it does not appear to be "totally killing the business." Adelson theorized that there is more room to widen than to tighten on structured product, but "it's not going to happen without a trigger event."

"Otherwise," according to Adelson, "I expect we will continue to go sideways with these very tight spreads."

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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