Although spreads in CDOs have moved out since Sept. 11, it is no secret that the market has been having credit problems for quite some time. Lately, however, deals with exposure to the airline, gaming, lodging, and tourism industries, as well as the insurance industry, have borne the brunt of rating agency action.

Seventeen of the 60 European CDOs that Fitch has rated were deemed to have exposure to the troubled sectors. For now the group has placed three classes from two synthetic transactions on ratings watch negative: the class B and C tranches C- Strategic Asset Redeployment Program 1999-1 (Citistar); and the C class of IKB Deutsche Industriebank AG. In the U.S., Fitch has placed 68 classes of 26 CDO transactions on ratings watch negative.

These actions were of little surprise to market observers, as both European deals were known to have exposure to the troubled sectors, and both had recently experienced defaults.

"Fitch is actively monitoring the implications of the recent events and will continue to do so in the current uncertain environment," said Marjan van der Weijden, a director in Fitch's CDO group. "We have screened all our European CDO's on exposures to industries that Fitch has identified as industries with increased risk, like the airline industry, tourism, gaming and insurance."

Tough times ahead?

While Fitch is closely monitoring portfolios with exposure to at-risk sectors, the developing economic landscape will dictate other new areas focus. According to van der Weijden, although the full impact has not crystallized yet, investors will start to look more for safe-havens. "A lot of European CDOs also have U.S. exposure," she said. "Transactions that are traditionally undisclosed will find investors demanding more disclosure."

Other issues, such as accounting changes and write-downs associated with Emerging Issues Task Force (EITF) 99-20, which requires portfolio managers to mark-to-market CDO equity, has exacerbated the problem. American Express, perhaps the most widely publicized example, wrote down as much as $830 million associated with CDO equity.

"The market here [at the start of the year] was swamped by U.S. activities," said Terence Shanahan, managing director and global head of structured debt at Societe Generale. "U.S. first-loss investors are now out of the market, most buyers went into Audit due to American Express. European investors stepped in [now] that is evolving. You will not only see that the first-loss buyers are in Europe but they are demanding European assets."

European buyers' are now focusing on collateral type and fund manager, adds Shanahan.


SG, which recently forged an alliance with U.S.-based TCW Group, expects the market to continue its interest in CDO investments. In the next five years the Group will acquire 70% of TCW. Off its own balance sheet, the group expects to launch Eurostoxx I and MORE III, both synthetic CDOs that are currently in the works.

Deutsche Bank was in the market last week toting a 114.5 million managed synthetic CDO for Abbey National Financial Products. Its Marylebone Road CBO 3 B.V. is the first European CDO to be launched in the European market after Sept. 11, and analysts following the deal say its pricing is encouraging. The triple-A notes priced at +45 basis points over the three-month Euribor, especially telling given the 9.5-year average life.

Alternatively, KBC Bank has a 214 million synthetic CDO in the works marking the second transaction of this kind for the bank. Cygnus Finance 2001-1 will be structured into one triple A tranche of 80 million, a double-A tranche of 46 million, a single-A tranche of 38 million, and a triple-B tranche of 20 million and a double-B tranche of 30 million.

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