While it is true that CDO volume is dramatically down for the year - 2002 year-to-date global cashflow CDO issuance is 43% behind issuance last year, according to Banc of America Securities - blame does not rest squarely on the shoulders of heavy rating volatility and proposed FASB accounting changes, market sources say; the fact that the CDO arbitrage in high yield (HY) and investment-grade (IG) corporates has been tightening significantly has not been helping matters either, they note.

Last week's increasing optimism surrounding a turning economy and second-quarter earnings prospects led to continued tightening in both HY and IG corporate-bond spreads. Since Feb. 22, for example, single-B HY bond spreads have tightened a full 110 basis points, according to Banc of America Securities (BAS) Large Cap Index.

Similarly, IG corporate triple-B's have tightened 20 basis points since their 2002 wides set on Feb. 22. This substantial tightening sent the BAS HY and IG CDO Return on Equity Barometers down 6.1% and 3.3%, respectively, to 19.3% and 20.0% under base-case expected-loss scenarios as of March 15.

In the stressed loss case, HY and IG corporate CDO Barometers stand at a notably low 9.3% and 8.7%, respectively, as of the same date. With these kinds of levels, HY and IG corporate CDO equity only looks attractive at the base-case levels, which many investors consider too optimistic.

On the other hand, HY Loan and Multi-sector CDO Barometers both rose over the last three weeks, reflecting their characteristically uncorrelated movement against corporate spreads. On the heels of a 31 basis-point rise in BB/BB- loan spreads over this same three-week period since Feb. 22, the base-case HY Loan Barometer has risen 3.9% to 18.5%. The Multi-sector CDO Barometer stands at 21.1% in the base case.

Meanwhile, according to BAS, as of March 15, year-to-date global synthetic issuance has reached $14.6 billion in 12 deals versus only $8.8 billion of cash issuance in 23 deals. As measured by notional, visible synthetic issuance is 66% higher than cash issuance.

So why is volume down so drastically? Rating and accounting uncertainty have contributed to a diminished issuance volume. Further, it appears that only proven managers that have outperformed indices and are able to help place a fair portion of the equity, with few exceptions, are able to come to market. Managers from lesser known shops are virtually required to place or keep well over 50% of the equity themselves.

"I am ready to do a CLO at anytime, but we can't get the equity sold to do it," said one bank loan manager. "Plus, I have issued one arb cashflow CLO already that is performing beautifully, outperformed the indices, and will take 49% of the equity, but none of the bankers I speak to are confident they can finish the job. The bankers expect me to be a salesman and run the portfolio."

On the other hand, consider a firm like Aladdin Capital, populated by ex-DLJ and Merrill Lynch bankers with strong connections in Japan. The firm has just hired Mizuho to help finish the equity on its new $400 million to $500 million cashflow CLO. According to sources, the firm's brass is well adept at selling securities, as they have had previous Street experience. Barely a couple of years old, Aladdin is readying its their fourth CDO in the first half, insiders say.

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