Differences in credit fundamentals - and the speed at which they are expected to change - should mean that ABS CDO spreads will begin to widen out much earlier, and faster, than spreads in the CLO space, Bear Stearns analysts said last week.
The analysts assumed that the market seems to be with them on this point: Spreads on triple-B ABS CDOs have generally averaged above 300 basis points since late last year, while triple-B CLO spreads continue to tighten, according to Bear.
Clearly the difference has lessened recently from a high of about 200 basis points reached shortly after the beginning of this year. Additionally, the market-wide search for yield has led investors deeper into the capital structure. However, Bear still recommends trading into a position that will take advantage of an expected widening divergence between CLO and ABS CDO spreads.
The portion of the capital structure with the least negative carry, and also where the spread difference between the sectors has remained below average since 2000, is the double-A bucket, Bear Stearns said. Traders could either buy a cash double-A CLO tranche and purchase protection on double-A ABS CDOs until the trade is duration-neutral, or seek to use CDS on both sides of the trade - if a double-A protection buyer can be found, Bear recommended.
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