CDO spreads are tight and a shortage of new issuance supply has helped drive investors into the secondary CDO market over the past year. But, according to market sources, a confluence of other events has helped spur that activity as well.
"We're in a more mature growth of the CDO market, but the most important thing that has changed is more transition to the secondary market. Investors are receiving better value and that's a very big plus," said David Tesher, a managing director at Standard & Poor's, speaking to attendees at last week's CDO conference hosted by the Information Management Network.
Improved sell-side research and the evolution of products offered by the rating agencies, combined with The Bond Market Association's CDO committee and a general agreement for more transparency in the market, helped to increase CDO liquidity last year. Market participants report activity is bubbling in the secondary market.
Certainly, it helped that valuations rose last year, said Christopher Ricciardi, head of the CDO effort at Merrill Lynch. But following the failure of three other bid lists, the first big catalyst seen in this market was the success of the CDO bid list originated from Abbey National Bank.
"Once that list cleared, it proved the market clearly had the infrastructure in place," Ricciardi said.
Structures have evolved as well, with recent CDO deals showing more benefit toward the noteholders, as rating agencies addressed a host of problems that arose out of the negative credit cycle.
This has created a different opportunity set for secondary market investors, noted James Finkel, CEO of Dynamic Credit Partners, a firm formed last November. The firm recently launched trading activities in the secondary market. Tighter trading ranges for senior debt have emerged, as the likelihood of "things getting out of hand" diminishes with the presence of improved structural enhancements, he noted.
Finkel stressed that investors should always know the intentions of collateral managers before plucking a deal. Noting that, for example, many high yield-backed CDOs have default situations, "each decision becomes a bigger one...as trading flexibility gets clamped down," he said.
The difference a year does make
In today's secondary market, mark-to-market summaries are available from at least two to three sources, said Dan Ivascyn, executive vice president at PIMCO. Getting the appropriate documentation in front of investors has been a big boost to generating activity, which combined with the tightening in collateral spreads, he said.
Adam L. Siegel, a managing director at Bear Stearns, agreed. What had stopped bid lists in the past was the fact that investors didn't have enough information about the CDOs contained in it. With increased transparency, plus Intex putting information out, "it's a two- to three-day turnover now," Siegel said of secondary trades.
David Weeks of Merrill Lynch noted certain rules of engagement need to apply to today's active market: Dealers should not step in front of clients and should not disclose one client's bid to another. One trend Weeks noted was the increased time frame as to when dealers will begin to disclose spreads. Prior to the success of the bid list, dealers had a lot more leeway, he said.
Investment banks, as a whole, have been putting more human capital to the CDO product, another factor aiding liquidity, noted Erik Siegel, a vice president at Morgan Stanley.
Now ABS- and TruPS-backed CDO bid lists have generated in the secondary market in the past three months. However, traders noted liquidity isn't guaranteed at the same level across all types of CDO products. "Obviously, the higher up you are in the capital structure, the more liquidity you have," Morgan Stanley's Siegel said.
High yield loans and bond-backed CDOs currently have more liquidity than asset- and TruPS-backed deals. The vintage has an effect as well, panelists said. Generally speaking, cash-backed managed CDOs trade with more liquidity than static cash deals.
"There is a lack of supply out there. Eight to ten dealers a day will play on a bid list," said Bear Stearns' Siegel, because they can't source paper.
"The one missing component is looking at equity returns - no clearing house for that information," said Managing Direct John Popp, head of leveraged investments group at Credit Suisse Asset Management.