Japan saw the first public CDO of ABS emerge last week, Dawning Global Asset Funding, a 69.3 billion (US$58 million) synthetic transaction originated by Sumitomo Trust and Banking.

The deal is backed by a portfolio of 70 billion (US$59 million) worth of domestic asset-backed securities, with a 25% portion of foreign bonds.

"This is the beginning of a new trend in the Japanese ABS market - an ABS investment exit strategy using CDOs, in a market where secondary trading of ABS vir-

tually does not exist," reported Chinatsu Hani in Merrill Lynch's Japanese ABS/MBS Bi-Weekly. "Repackaging of notes also allows originators to achieve higher returns on low-yielding ABS investment portfolios, by retaining the most junior tranche."

Though Dawning Global Asset Funding I represents the country's first publicly rated structured finance CDO, Moody's Investors Service has already rated one such transaction on a private basis, said Keiko Kurasaki, senior vice president at Moody's in Tokyo.

"Right now ABS volumes in the public market are becoming smaller; this is because many deals are being sold on a private basis," she said. Institutional investors will likely pick up whatever's out there, so the collateral scarcity may be an issue for ABS CDOs. "I would expect to see two to three more structured CDO deals emerge, but that's the maximum."

During the first quarter, Moody's rated nine CDOs worth approximately 3.02 trillion (US$25 billion). The volume was described as remarkable compared with 2002's total issuance figure of 3.14 trillion (US$26 billion).

An uptick in balance-sheet CDO issuance was driven by the Japanese mega-banks, including Mizhuo Corporate Bank, Sumitomo Mitsui Banking and UFJ Bank, which were actively issuing balance-sheet CLOs in the first quarter

"At the end of the Japanese fiscal year, which occurs in March, we saw large bank balance-sheet driven CDOs, issued by large banks for balance-sheet management purposes," says Kurasaki at Moody's. "We may see more issuance of these mega-CDO deals, maybe one or two deals, before the year-end."

But in the second quarter, the market slowed down, mainly because many issuers shifted their deals to the private market, to save on transaction costs. "We have seen the market contract, so that in the second quarter, it is now one-tenth of what it was in the first quarter," says Kurasaki. "Issuance in the CDO sector in the first quarter was very high and stood at around 3 trillion (US$25 billion); however, in the second quarter this has dropped down to 0.3 trillion."

The continuation of the trend in large balance-sheet CDO deals largely depends on the Japanese banking environment and whether banks will continue to have incentives to issue balance-sheet CLOs. Balance-sheet management has been the main driver of market growth.

In terms of the synthetic arbitrage CDO sector, investors are not likely to enjoy enough spread as long as the current tight spreads continue in the Japanese corporate market. However, Moody's says that multisector CDOs - such as CDOs of ABS - and managed CDOs might see some market growth.

"In the first half of last year, we saw a proliferation of arbitrage CDO deals, which were motivated by market conditions and wide spreads, and provided attractive opportunities, for intermediaries and investors," explains Kurasaki.

CLOs and SMEs

Another area where there could be substantial increases is in CLOs backed by loans originated solely for the purposes of securitization.

"Last year, the Japanese government made it a policy matter to help the SME sector, and we saw the origination of many primary CLOs (which we describe as CLOs backed by loans, which were intended for securitization from the onset)," said Kurasaki at Moody's. "We also saw some CDO issues which had benefited from the support of local governments such as Osaka and Tokyo, and which have both helped to create CLOs, to provide support to the SME sector."

Furthermore, the Bank of Japan (BOJ) initiative announced in June, an effort to purchase ABS and ABCP, has also been based on a political incentive. The aim of the initiative was to boost the SME sector.

"Following the BOJ's move, we will see more CLOs issued, especially if, as the BOJ says, it will become involved in purchasing the lower tranches," said Kurasaki. "This measure might help banks that do not wish to keep a large equity portion. However, it could be very detrimental to the ABS market if the BOJ purchases the higher-rated tranches, as they could crowd out investors from the market, which are already hungry for ABS paper."

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