NEW YORK - Credit default swaps are being used on a rapidly growing number of asset securitization deals, a performance matched only by the innovations that are emerging to make the most of the market's growth. That was the message delivered last week by panelists at the "CDS of ABS - Securitization's New Frontier" seminar.

However, one major challenge lies ahead for the CDS business: luring a more diverse group of players into the market.

The notional outstanding on CDS-enhanced ABS deals, a market that kicked off in 2005, is about $150 billion. Some market players expect that amount to double by 2007.

To make the market as efficient as possible, traders potentially have a couple of transaction strategies to try this year, said Louis A. Nees IV, a senior managing director at Bear Stearns. In one scenario, traders might be able to complete trades hoping that a security's "A" piece will appreciate, versus selling another segment of the same deal, perhaps the triple-B portion, said Nees. In another situation, particularly with the ABX index, traders could go long on an index from one year while shorting the index from a different year.

By the second and third quarter, a significant number of new entrants, including insurance companies and more traditional money managers, could enter the market. Credit default swaps might allow insurance companies to reign in credit exposure to loans on their books without having to sell them. It might give them the flexibility of managing their large loan portfolios in smaller chunks between $10 million and $50 million, as opposed to $300 million at a time. They might also have the freedom to manage the credit risk in their portfolio assets without having to wait for their dealer's inventory to clear before doing an asset securitization, said Nees. And considering that most CDS volume has been in subprime retail mortgage-backed securities deals, asset originators such as home equity lenders might be interested in joining the fray. They could use the credit default swaps to ensure more stable yields on loans awaiting securitization, he said.

Aside from generating more liquidity for the market, the presence of new CDS professionals could have a more stabilizing impact on spreads. The triple-B ABX index, for instance, traded in a three-point range over the past six weeks.

"As more participants get involved in a market, who have different decision points, this creates more liquidity and tends to stabilize market movements," Nees said.

Bear Stearns, along with 13 other market makers, launched the CMBX.NA, a synthetic index of U.S. commercial mortgage-backed securities. Similar to the ABX index launched in January to track ABS deals, the CMBX.NA will be based on 25 of the most recent CMBS deals. Qualifying deals must total at least $700 million, and one bond from each deal will be referenced in each index, according to Markit, the pricing and valuations service firm that will administer and market the index.

Sponsored by the American Securitization Forum, the seminar drew about 200 asset securitization professionals.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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