As collateral warehouse lines tightened and deals unwound amid subprime performance fears, the mezzanine ABS CDO sector saw its slowest monthly volume in April since November 2005. The volume dropped 75% to $3.5 billion from $13.5 billion in March, according to Lehman Brothers.
And while some extol the virtues of mezzanine ABS CDO issuance in the current environment, others say the difficulty in placing debt could result in a prolonged dry spell for the sector.
"It's really hard to place the debt," one CDO asset manager said. "I think it is going to come back, but I think it is going to be a while." An increasingly opaque pricing environment has led to uncertainty for a number of managers thinking about constructing a mezzanine ABS CDO, as they have little idea what their liabilities might sell for.
The mezzanine structured fi-nance CDO pipeline was $6.1 billion as of May 14, according to JPMorgan Securities, compared with a $20.3 billion pipeline for high-grade structured finance CDOs and an overall $57.7 billion funded global CDO pipeline.
The fact that only four mezzanine ABS CDOs priced in the month of April is "suggesting that the pipeline of deals ramping prior to February is largely behind us and we should expect to see little mezzanine issuance over the short-term," Lehman analysts wrote last week.
And for those that want to get a deal done, it's not proving so easy. A lack of liquidity in the single-name CDS market has crowded a number of CDO managers - most of whom are looking for 2007 collateral - into the cash space.
As a result, ramp-up periods for cash deals are expected to become longer in the near future, as the collateral is proving increasingly difficult to come by. Mezzanine pieces of new-issue subprime deals are, in some cases, being sold on a forward basis, sources said last week, leading to a scramble for any available collateral.
"Single name CDS has dried up quite a bit, so the ability to aggressively ramp up a deal like we saw in 06 has gone away," another CDO asset manager said. "We are relying on the cash market more, and HEL issuance is down." The source anticipates that deal sizes will decline, moving closer to the size of CDOs issued in 2003 and 2004.
Expectations of longer ramp-up periods and a new-found fear for HEL pricing volatility has led some market players to develop new funds aimed at carrying that risk, sources say.
Nonetheless, mezzanine ABS CDO equity returns are currently at all-time highs - making constructing such deals lucrative right now for those big enough, and with relationships in the right places to get them done.
JPMorgan analysts project that mezzanine SF CDO equity would yield 4,611, 4,085 and 3,285 basis points over Libor, respectively, in three progressively sour U.S. housing market scenarios. Comparatively, triple-B notes in the worst scenario would lose 825 basis points, earn 13 in a moderate scenario and 488 in the best-case scenario. Triple-A notes would yield 35 basis points, nine basis points and negative 112 basis points in the three situations. The returns are based on an assumed collateral spread of 395 basis points and annual CDO fees of 70 basis points.
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