With the finalized numbers now in, it appears the market for collateralized debt obligations in Japan cooled its heels when it came to new issuance last year.

Moody's Investors Service said this week that 20 Japanese CDOs were rated in 2004 for a total volume of 0.72 trillion. This was a dramatic drop in issuance. In 2003, Moody's rated 4.24 trillion of Japanese CDOs. However, there was significant CDO upgrade activity in this overseas market.

Analysts noted the drop in the average size of CDOs last year is due, in part, to a decrease in the number of balance-sheet CDOs by financial institutions targeting portfolio risk management plays. This coupled with an increase in primary CLO/CBOs backed by private bonds and loans for SMEs that were originated for the sole purpose of securitization.

"Primary CLO/CBOs are created using corporate loans where financial institutions advertise for and select eligible loan applicant SMEs within a given period," Moody's analyst wrote, "[and] their sizes are necessarily limited."

In addition to the rise in popularity of CBOs backed by SMEs - growing to almost 50% of total issuance last year - Moody's report states five CLOs backed by secured sub-performing loans and five CDOs of equity default swaps were issued in 2004.

Moody's also rated five synthetic CDOs worth $135 million. These synthetic transactions referenced, primarily, non-Japanese names and were purchased by Japanese investors. The tight spread environment meant there was little arbitrage opportunity in Japanese names, leading investors to arbitrage synthetic CDOs referencing global names. "If the situation continues, global names will become the mainstream in the 2005 Japanese arbitrage CDO market," analysts wrote, adding that managed arbitrage CDO deals are likely to increase next year.

Overall, four CDOs vehicles saw a total of eight tranches upgraded last year and there were no downgrades of Japanese CDOs reported by Moody's in 2004. The 126.1 billion Gannet II Funding Corp. CDO originated by UFJ Bank was the largest CDO by volume.

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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