Not surprisingly, Enron Corp. and its impact on the market was the hottest topic at last Monday's synthetic CDO conference put on by Financial Research Associates.
Spicing things up a bit, one rating agency analyst commented that of the six managed synthetic CDOs the agency rated in 2001, five had Enron exposure, and the sixth deal probably would have had there been more time to stuff it in its portfolio. The analyst added that, most likely, all five of the Enron exposed deals will see mezzanine tranche downgrades.
Jeffrey Tolk, a senior credit officer at Moody's Investors Service, took a calming tone on the Enron debacle: fallen angels are not new to the CDO market and the industry will remain fairly unshaken from the event, he said.
"Some might call the Enron fallen angel a thousand-year event, but it seems like these thousand-year events keep happening," said one conference participant. Moody's expects defaults to peak in first quarter next year.
But not everyone at the conference wanted to hear about Enron. Said one conference participant: "I'm tired of hearing so much about Enron on the panels, which everyone already knows about. I feel like asking them what company is going to be the next Enron."
It's important to remember, however, that the CDO market withstood the bankruptcies of companies exposed to asbestos claims, as well as the energy crisis in California. While there have been downgrades, these deals are modeled to withstand a fair bit of stress, Moody's Tolk said.
Nik Khakee, a director at Standard & Poor's, said there's a current debate over whether investment grade CDOs holding Enron paper should sell out of the problem name. He added that one CDO client told him that he did not foresee the Enron paper gaining value in the future once the current "short-squeeze" created by counterparties covering positions subsides. However, one banker in the crowd made a case for holding the paper, since it may become a hot name for vulture funds.
A point that the ratings analysts on the panel agreed upon is that it is too early to tell whether arbitrage, cashflow, balance sheet, managed, or synthetic CDOs perform better than others - all have seen their fair share of downgrades. Tolk summed up his presentation with the synthetic CDO trends seen in 2001: new reference pool asset classes, such as ABS, CMBS, MBS, CDOs, and others; new risks referenced, such as derivative counterparty exposure; a move toward arbitrage structures; structural enhancements, such as amortization triggers, and traps for excess spread; and lower credit quality reference pools.
Meanwhile, according to Scott Gordon, a managing director at Ambac Assurance Corp., the monoline will have written between $25 billion and $30 billion in credit default swap protection to collateral managers issuing triple-A super senior synthetic CDO tranches. These derivatives contracts are rated triple-A, which allows the credit-sensitive monoline insurers to participate in this line of business.
Lori Evangel, a managing director and group head in the CDO group at MBIA, concurred with Ambac. She estimated that 65% to 75% of her department's book of business is also super-senior triple-A CDO-tranched basket default swaps. Evangel added that she will not sell protection if the CDO is a blind pool of credits, with the rare exception of regulatory-driven, bank balance sheet CDOs with a very large group of names providing diversification.