After being billed as one of the best new opportunities for financial guarantors, it turns out that fewer collateralized debt obligations (CDOs) featuring credit enhancement are coming across investors' plates, observers say.

Though CDO volume fell far short of expectations in the first quarter - only recovering in recent weeks - guaranteed transactions have been on a noted decline from 1999 levels.

"We're looking at the deals that have been done this year and a lower proportion of them have been wrapped compared to last year," said Jeremy Gluck, an analyst with Moody's Investors Service.

Through the first half of 1999, guarantors have insured about $34 million worth of product in the CDO market. Yet thanks to a robust fourth quarter of CDO issuance, many investors' appetites have been smaller going into 2000. Making matters worse is an inhospitable market for new high yield and syndicated loan volume - the underlying assets of most CDOs.

"The arbitrage gap between high-yield bonds or syndicated loans and liabilities were wide in the first quarter," said Gluck. "There was also very little issuance in the high-yield bond and syndicated loan market."

But sources say the market has to some degree snapped back in recent weeks. Arbitrage has become more attractive as spreads in the high yield bond market have widened. But the market may face hurdles if investors prefer extra yield to credit protection, or if the high-yield market experiences rising default levels.

Though not new in other sectors of the debt market, insured CDO volume gained prominence during the global volatility of 1997. Financial Security Assurance was the first insurer to wrap a CDO transaction in 1988, but it wasn't until years later that MBIA and Ambac began credit enhancing CDO transactions.

Many of the guaranteed deals are placed in the Rule 144A market and contain a portion of emerging market underlying credits. Ambac, for example, claims about 34% of its outstanding CDO exposure is from emerging markets.

Exotic CDOs?

Beyond that, a growing number of CDO issuers are pushing the envelope in other ways, using various asset-backed securities classes to support their offerings, analysts said. These "re-securitizations," as they are termed, are backed by asset- or mortgage-backed securities or other structured instruments.

"I think there seems to be a real push to find other illiquid assets, especially going down to junior tranches," said Moody's Gluck.

Just last week, Warburg Dillon Read and Donaldson, Lufkin & Jenrette pitched a $1.2 billion collateralized bond obligation backed by investment-grade corporate and asset-backed bonds in a transaction designed to protect investors from a number of risks except default.

According to the details revealed of the transaction, Warburg parent UBS will take most of credit risk of underlying collateral, including spread widening, prepayments and trading losses.

The North Street Reference Linked Notes carry a five-year maturity, and carry ratings from triple-A to double-B-minus. A floating rate piece sold off the three-month Libor.

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