Indeed, U.S. CDO issuance was up, totaling $188.3 billion through the first half of 2007, a small but not insignificant rise from $147.3 billion for the same period in 2006, according to Thomson Financial data.
Merrill Lynch remained entrenched in its number-one spot for the first half of 2007, a position it also held in the first half of 2006, with a 16.8% market share and 36 issues, Thomson said. Citigroup Global Markets continued to hold steady at number two from the first half of 2006, also with 36 issues but a market share of 14.2%.
The biggest gains in the first half of 2007 occurred in the third and fourth slots of the league tables. Wachovia Securities jumped to number three with 7.8% of the market, from eighth place in the first half of 2006, while JPMorgan Securities slid into number four with a 6.5% market share, a major rise from 15th for the same period in 2006.
Other notable moves this half included a rise to sixth place for Morgan Stanley from 12th in the first half of 2006 and a slip by Deutsche Bank to number seven from third place for the same period.
Part of the driver behind the sustained CDO issuance, particularly for ABS CDOs, has been banks emptying their warehouses as opposed to new issues hitting the market, a trend that market pundits agree has come to a close as banks have completed the job.
The second quarter of 2007 was not as strong as its predecessor. Though Citigroup jumped to first in the second quarter from its number-two position in the first quarter, its number of issues declined to 11 from 19 and volume rose only slightly, to $13.6 billion from $12.91 billion. Merrill, though remaining the first half's leading bookrunner, took a larger hit in the second quarter, dropping to number two with only 11.2% of the market and $10.3 billion in volume. This was a far cry from its number-one position last quarter with a 22.9% share of the market and $21.3 billion in volume.
HEL Sector Is To Blame
The reasons surrounding the market's volatility have been splattered across the headlines as the collateral behind ABS CDOs continues to suffer. Supply of U.S. ABS in the first half was $380 billion, a drop from $409 billion for the same period in 2006, according to a report from JPMorgan Securities. The home equity sector also dropped, to $179 billion from $270 billion in the first half of 2006.
Collateral pools for first-half 2007 HEL ABS showed some improvement in a few key characteristics, but overall quality was not significantly higher, JPMorgan said, noting that deterioration in home equity ABS performance worsened for the more recent vintages. While 2007 subprime 60-day plus delinquencies started out slightly better than the 2006 vintage, they are quickly turning south, the bank said. In June, the ABX 2007-1 registered the largest month-over-month increase in serious delinquencies at 2.11%, according to Citigroup.
The lack of support behind [ABS CDOs] has also been evident. "No one is willing to put money to work right now," a trader said. "The natural buyers are out of the market. A lot of the guys that have the money to put to work in this sector are being restricted on what they can buy."
Outside of ABS CDOs, the prospects are much more optimistic, particularly for investment-grade credit CDOs, according to a report from Barclays Capital. Those will be supported by positive credit fundamentals and low levels of corporate defaults, the bank said.
There has also been an increase in higher quality this quarter, with deals that are backed by collateral with higher average ratings - moving away from the mezzanine-type structure and toward the higher grade, said Yuri Yoshizawa, managing director in structured finance at Moody's Investors Service. There has also been a pickup in the CDOs of CDOs and CDOs of CLOs, she added.
As previously mentioned, the inclusion of CLOs is a big factor in the ongoing growth of the CDO market. CLO issuance has continued to be strong, both in the first and second quarter, Yoshizawa said, noting a small increase in multicurrency loan facilities as a result of managers adding European assets into U.S. CLOs.
Keeping on the asset side of CLOs, while the loan market has been increasingly risk averse with continued spread tightening, CLO managers have recently been given more control over the loan issuance process, said Brian McManus, head of CDO research at Wachovia Securities. He suggested that it was a direct result of questions surrounding the hedge funds and hedge funds selling some of their positions in loans. CLOs provide term funding, and investors, such as hedge funds, that fund on margin are vulnerable to market-to-market swings, McManus said. The term-funding nature of CLOs passes the market value volatility onto the noteholders, which speaks well when it comes to being a long-term buyer in the loan market, he said.
However, the CLO market is not immune to broader CDO market pressures, and in particular, pricing instability, with spreads seeming to hold firm only in triple-A CLOs. In mezzanine notes of CLOs - specifically, single-A and below - spreads have widened, which has caused trepidation for new issuance in the market. "When you have this much volatility, you really can't figure out the price of a deal, and you have to be careful about your warehouse risk," McManus said.
Indeed, market participants are chewing over the ABS CDO market's ballooning effect on new CLO issuance, which could reduce investor interest in the product. As investors face the potential of larger margin requirements - increasing 50% to 100% anecdotally from a few months ago - new issue activity could continue to slow at a time when loan and CLO pipelines are at or near record levels, JPMorgan said.
The Other Half
As the market enters the second half of 2007, there is also uncertainty about the amount of cumulative losses in the ABS CDO market and whether the losses will be as bad as anticipated. "In the long run, it may not be quite the beast it has been made out to be," McManus said. "But the weak subprime underwriting standards is a lesson to be learned. CDOs are an excellent financing vehicle, but that does not guarantee the funding it raises will be wisely invested."
Over the next six months or so, market players expect a slowdown in issuance. But when the market does stabilize, with more stringent lending standards, there is not much doubt that ABS CDOs will be back on sturdier ground.
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