Last week, Lehman Brothers brought to market a US$57.5 million, arbitrage synthetic CDO, Golden Jade CDO, with the Agricultural Bank of China acting as portfolio manager. This transaction represents a growing trend in non-Japan Asia, where the managed arbitrage synthetic CDO sector is becoming increasingly active.
The synthetic CDO market has been pretty active in Asia this year, confirms Jerome Cheng, vice president in the structured finance group at Moody's Investors Service in Hong Kong. "This year we have already rated four synthetic CDO deals, including Artemus arranged by HVB, two transactions arranged by Lehman Brothers, Ruby Finance and Golden Jade, as well as Merlion, arranged by JPMorgan Securities and DBS Bank in Singapore." It's expected that there will be at least the same amount of deals issued this year.
"Before the Asian financial crisis in 1997, we saw a number of cash- flow CDOs; however, now we see more synthetic CDOs," says Cheng at Moody's in Hong Kong. "This is because there is less availability of cash bonds in the market, while, on the other hand, the CDS market has become a deeper and more liquid market, with more names trading," he added.
Singapore and Hong Kong are the hubs of activity, at least in terms of portfolio managers, but there is talk that a CDO is also being structured in Korea. "Singapore will continue to be a source for new deals, as both the portfolio managers in Singapore and the investors are very familiar with the CDO product. This is coupled with the support that the Singaporean authorities are giving to the development of the capital markets," explained Cheng.
But the latest deal to emerge, Golden Jade, was also interesting because it involved a portfolio manager based in China, which may well signify an important new trend. The Agricultural Bank of China is rated Baa1'/'P-2'by Moody's, and is a wholly state-owned commercial bank incorporated in 1979 in Beijing. However, this deal is not the first foray for this bank in CDOs, as in May, Goldman Sachs arranged a US$1.5 billion CDO, also managed by the Agricultural Bank of China.
However, the recently rated Golden Jade Synthetic CDO, was in fact the first time that a portfolio manager from the People's Republic of China (PRC) was utilized in a Moody's-rated synthetic CDO transaction. "This is a very interesting development, and there is potential for deals to emerge with a collateral manager from the PRC," Cheng said. He added that these types of transactions create new sources of revenue for Chinese portfolio managers, as well as give them the ability to tap the international investor base. Cheng added that although there was definitely some potential for more deals to emerge from China, this was also very much dependent on investor appetite.
The Golden Jade CDO was divided into the following tranches, and rated by Moody's as follows: US$20 million class A notes due 2006, rated Aaa'; US$10 million class B notes due 2006, rated Aa1'; US$27.5 million class C notes due 2006, rated A3'.
As has been the case with other deals launched this year, the reference portfolio has been for the most part geographically concentrated in the United States and Europe, with a minor portion of Asia credits. Golden Jade consists of 120 reference entities, with an aggregate notional amount of US$1 billion. At closing, approximately 67% of the reference entities are in the U.S., 22% in Europe, while the remaining 11% are in Asia and Australia. These reference entities have a weighted average credit quality of Baa1'/ Baa2' and a diversity score of 72 from Moody's. The reference portfolio is well diversified in terms of industry composition, with reference entities coming from 31 different industries out of the 33 Moody's industry classifications.
Another CDO that closed this year was for the Singaporean Bank United Overseas Bank (UOB), a US$1.7 billion synthetic CDO backed by credit defaults swaps, lead-managed by Goldman Sachs. UOB has now completed a total of three CDOs. The deal was backed by CDS from a range of corporate borrowers located across the U.S., Europe and Asia, and was rated by Standard & Poor's.
But what is the potential for growth in this market? "Synthetic arbitrage CDO transactions are driven by credit arbitrage, and therefore these deals are very much dependent on the availability of arbitrage opportunities," explains Moody's Cheng. "In these last few weeks we have seen spreads tightening, and it is debatable whether at these levels we will continue to see a proliferation of these types of deals."