Ashmore Investment Management and Singapore-based UOB Asset Management launched the first emerging markets collateralized debt obligation of the year with lead arranger Lehman Brothers in late March, heralding what could be a recovery for the asset class. The Russian crisis brought the issuance of emerging markets CDOs to a screeching halt for roughly two years, but a smattering of deals in 2000 and Ashmores re-entry into the market with a $170 million instrument indicates that investor demand is coming back.
"The timing was right," said Jerome Booth, a director at Ashmore. "Spreads on emerging markets debt are unsustainably high and we were able to lock those spreads in. More importantly, the demand was there." Ashmore was able to place all of the issue, including $22.1 million of Class D unrated preference shares. Typically CDO issuers are forced to hold onto the most subordinated piece of the instruments.
Ashmore and UOB broke the issue - entitled Atlas CDO I - into four tranches. The eight-year Class A tranche is the largest at $30.5 million and features a Aaa/AAA rating thanks to a wrap from Financial Security Assurances (FSA) that helped secure pricing of 55 basis points over Libor. The $3.8 million 10-year Class B piece is rated Baa2 and priced at 275 basis points over Libor while the $13.6 million 10-year fixed-rate piece is rated Ba2 and priced to yield 13.07%. The preference shares are unrated and offer an internal rate of return of 21%.
The portfolio of assets backing the CDO contains an 80% sovereign component and has a wide geographic distribution in order to minimize contagion risk. Roughly 25% of the underlying assets are from Latin America, 30% are from Asia 7.5% from Africa and 15% from Eastern Europe. The remaining 25% consists of investment-grade credits throughout the emerging markets.
Ashmore's decision to launch Atlas follows Phoenix Duff & Phelps' sale of a $250 million emerging markets CDO in August of 2000 and could mark a recovery for the asset class. Issuance of all emerging market CDOs disappeared after the Russia crisis when the investment-grade and crossover buyers that typically buy senior CDO tranches developed severe aversions to the paper. But the gradual improving perception of emerging markets has lured the buyside back and instruments with strong sovereign components should fare well going forward, Booth said.
"Emerging markets are perceived as very volatile but for this type of instrument the key is not volatility, it is the default and recovery rate, and with a 0.5% default rate and a 75% recovery rate, emerging markets sovereign debt compares favorably," Booth said.
Part of the success of future deals will also depend on securing an international investor base, it seems, as a key to closing the Atlas transaction was bringing in accounts from Asia through UOB.
