Like a tuft of grass in rocky terrain, emerging-market CDO Trabuco took hold in a difficult market late last month. Rated triple-A by both Moody's Investors Service and Standard & Poor's, the US$93 million, 12-year transaction priced at 50 basis points over Libor and is backed by a variety of emerging market bonds, loans and synthetic exposures.
"There's been a lot of difficulties getting [EM] CDOs done," said a source familiar with the deal. "It's the general market sentiment more than anything else."
Deutsche Bank Securities led the deal for asset manager Pacific Investment Management Co. (PIMCO).
The transaction featured a wrap from Ambac, scoring the senior tranche its triple-A rating. The deal features approximately US$35 million in unrated equity. According to one CDO analyst, it's the subordinated pieces that have fouled some investors on the asset class. "It's been a hard market because the subordinated parts are a tough sell," he said, "even though the equity investors in the deals I've seen are getting a respectable cash flow."
Other market watchers point out that EM CDOs have generally done a good job of weathering the crises that have buffeted emerging markets since Thailand devalued in mid-1997. "In terms of performance, they've actually been one of the bright spots this year," said Jeffrey Stern, a partner at Thacher Proffitt & Wood.
Mirroring other EM classes, CDOs have had their ups and downs over the last few years. Activity ground to a virtual halt after the Asian and Russian debacles. Then the market made a recovery, only to be shoved back down by the fall of Argentina. One analyst estimated that about US$638 million of emerging-market CDOs have priced so far this year.
For risk-hungry equity investors, EM CDOs have a sharp advantage over other types as the price volatility far exceeds the actual credit risk, according to analysts.
Though the category has proven itself over the last few years, one deterrent for some investors is its low level of diversity compared to CDOs backed by U.S. high yield bonds. In the case of Trabuco, Moody's diversity score was 17, which was on the high end for EM deals, but shy of the 40-60 ratings normally assigned to comparable U.S. high-yield CDOs. The diversity score gauges the market correlation of the underlying assets.
Trabuco's asset pool consists overwhelmingly of sovereign securities, according to a source close to the deal. "Latin America is definitely the largest part of the breakdown," he said, adding that a "reasonable amount" is allocated in Eastern Europe, while Asian credits such as South Korea are in the batch as well. The little corporate exposure of the CDO is made up of quasi-sovereign state companies. The mix includes investment-grade credits other than South Korea, which is rated A-/A3 by S&P and Moody's, respectively.
One source said the deal enjoys an excess spread of roughly 220 basis points. The average weighted floating-rate coupon on the paper is 450 basis points, while the floating-rate cost of capital totaled about 230 basis points.
The transaction is named after Trabuco Canyon in southern California. Trabuco is the Spanish word for the blunderbuss, a short musket with a flared-out muzzle used by soldiers on an expedition to the site in the late 18th century. The troop christened the canyon "Trabuco" when one of them lost his firearm near its mouth.
