Synthetic and investment grade cash CDOs referenced to corporate names may have taken a slight hit this week, while structured finance CDOs remained stable as investors reacted to the corporate credit downgrades to junk status for Ford Motor Co. and General Motors Corp. by Standard & Poor's.
Most of those deals have about a 1% to 2% exposure on average to the names, according to JPMorgan Securities, and at least $10 billion of GM, GMAC, and Ford is referenced in the synthetic structured credit market. Some downgrades occurred, but it was unclear whether they were due to GM and Ford exposure, and according to JPMorgan, the risk of future downgrades lies with CDOs that have already experienced credit deterioration - giving them less leeway to withstand future credit deterioration, without sacrificing built-in protections.
Last Wednesday's S&P's downgrades of several synthetic CDO structures managed by Deutsche Bank were rumored to be caused by exposure to the companies, but S&P analysts said in a conference call last week they did not anticipate the new corporate credit ratings to trigger CDO downgrades, due to the limited exposure in cash flow and synthetic deals.
In most cases, the effect on CDOs will be a higher weighted average rating factor, and more bonds falling into high yield buckets - but while these could limit management flexibility, forced selling is not likely, according to a JPMorgan report on the matter.
Mezzanine tranches in static index trades actually tightened by five-to-20 basis points last week, while the mezzanine tranches of managed investment-grade CDOs widened by two-to-three basis points, according to JPMorgan.
Meanwhile, there was little-to-no immediate impact seen on cashflow CDOs backed by asset-backed securities.
"As long as collateral performance stays strong, there should be not be any downgrades on the ABS programs," said one asset manager.
ABS spreads of GM and Ford are not expected to widen substantially as a result of the downgrades. At least on the ABS side, investors have grown increasingly confident in the legal separation of trusts from issuers, said Gyan Sinha, a senior managing director at Bear Stearns & Co.
"Given the history of the market today, investors are more and more comfortable with the notion that these can be independent entities with distinct and separate ratings, and that is why investors have continued expecting buying paper at such tight spreads given what has happened in the unsecured market in the last several months," Sinha said.
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