Concurrent to the long-term improving credit story in some emerging market regions, the recent blowout in spreads is creating opportunities for cashflow collateralized debt obligations, though a decline in crossover investors will limit the activity, analysts said.
"You can view it as a positive, if you believe in a region and believe in the name: that now with spreads widening, the assets are cheap," said Eileen Murphy, managing director of the global CDO group at Chase Securities.
However, because of the stigma associated with the Russian default in 1998, and subsequent problems suffered by a number of emerging market CDOs, current debt vehicles with EM buckets greater than 5% pay a significant premium when they come to market (if the primary asset type is U.S. high yield).
Essentially, the number of investors who buy both U.S. high-yield and emerging markets assets has declined over the last few years, said Glen McDermott, head of global structured bond research at Salomon Smith Barney.
A number of the emerging market CDOs that ran into trouble following the 1998 crisis did so because some managers did not fully understand the credit of each underlying emerging market exposure, as opposed to there being fundamental credit problems, market sources have said.
In that case, managers were executing credit risk sales, or sales at a discount to par, during a flight to quality. However, it wasn't clear whether managers were responding to price movement, or to the underlying credit story.
"Cashflow CDOs are all about maintaining par, so even if the market value of an asset declines, as long as the manager understands the credit story, price volatility becomes less important," McDermott said. "Problems occur when a manager is managing to price movements rather than to underlying credit fundamentals."
The result is that today's CDO market won't buy into emerging market CDOs unless the manager has an extensive track record with the asset. Moreover, if a CDO has a larger-than 5% concentration of emerging market assets, it's likely to be the primary asset-type in the vehicle.
Still, research suggests that operating conditions in countries such as Brazil and Mexico are improving, which theoretically would have a positive impact on the corporate credit, despite spread blowout, said Kevin Kime, an associate director at Standard & Poor's Credit Ratings Service.
"The fundamental economic picture might not have changed from the previous week, but all of a sudden [investors] can be more risk averse, so their appetite for risk changes," Kime said.
As for sovereign ratings, emerging markets research from Salomon Smith Barney names Brazil, Columbia, Ecuador, Mexico, Peru and Venezuela as showing improved credit over the next 12 months.
