Asset Securitization Report recently spoke with Armand Pastine, a managing director and newly promoted fixed income group head for Maxim Group LLC, about his thoughts on the CDO market. Maxim Group, a 400-person boutique investment bank, is an underwriter and issuer of ABS CDOs. Maxim's affiliated company, Maxim Advisory, has more than $4 billion in assets under management.
Asset Securitization Report: What would you say were some of the biggest developments over the past year within the CDO market?
Armand Pastine: Clearly, the advent of the [credit default swap] market for ABS has made the market more efficient and less reliant on the delivery and market float of the cash ABS sector. The CDO market has been going through a maturation process for the last couple of years, and that trend will continue. I would peg the maturity level somewhere around where the CMO market was in 1988 to 1990, given the level of sophistication, structure and liquidity.
ASR: What about some of the corporate credit events that occurred in 2005, such as the corporate credit rating downgrades of Ford Motor Co. and General Motors Corp.?
AP: The downgrades and defaults we have seen in the automotive sector have put considerable pressure on the synthetic corporate CDOs (corporate bespokes), and the entire corporate correlation trading industry was thrown for a loop back in [the] spring of 2005, as market-based correlations deviated substantially from the model-based output. Interestingly, the performance of ABS structured finance backed CDOs did not miss a beat during that period of instability.
ASR: Where do you see power in the CDO underwriting space shifting this year, especially as huge players such as Merrill Lynch lose some of their top talent?
AP: I predict Merrill will retain its No. 1 ranking in the CDO underwriting league tables. Merrill may have lost its CDO group head, Chris Ricciardi, whom most consider a very significant player in the CDO market. But that's only half the story. Merrill Lynch has a very deep bench and there are many talented people over at ML like Ken Margolis and Harin De Silva, who have been critical in building that business to what it is today, and were promoted [to] co-heads of Merrill's global CDO group. Both colleagues and competitors agree that Ken is one of the most influential architects of the CDO and credit derivatives industry, while Harin is one of the early visionaries that helped shape the evolution of the CDO construct into a critical component of the capital markets universe.
I think that Merrill could actually increase its market share this year with newly appointed people finally getting a chance to show what they can do with them in charge. Chris' departure actually is a plus for the market, since it will reposition yet another firm, Cohen Brothers, as a potential additional player in the business, if they choose to grow that business. Merrill Lynch has been very good at building a very deep bench, a very wide base of talent. For our CDO unit, they've rotated on each deal who the lead banker is going to be. And we couldn't be happier with them.
ASR: How do you think investors will treat start-up firms with seasoned market players? Will they be hurt because they lack a well-known name?
AP: I know there is a trend out there, or a tone out there in the market, that has been poo poo-ing these start-up managers. I would say that when you bank an issuer, you are not banking an institution, you are banking the people that are putting the trades on every day. When we first started out, we had people look at some of our deals and say we didn't have enough [of a] track record as a firm. But we looked at them and said, "We have over 50 collective years of experience in the field." I've seen good and bad deals from both newly formed small institutions and old-line large ones, but the common thread behind the good performing deals is the individuals that put the deals together. If you think about it, I'd be more inclined to bank on someone who has their own skin in the game.
ASR: Where do you expect CDO new issue and secondary spreads to trend?
AP: I think that CDO spreads will remain range-bound. It remains fundamentally cheap relative to other similar-rated securities. The triple-B rated tranches may trend tighter, as concerns over an overheated housing market and over-leveraged U.S. consumer abates. However, based on the demand for incremental yield, the CDO market will enjoy substantial sponsorship in 2006.
ASR: Do you anticipate RMBS to remain a dominant collateral in CDOs?
AP: Absolutely. The empirical performance of this sector is second to none. And I think it should be more dominant than CLOs. I think, fundamentally, the mortgage market is an extremely efficient, well-priced market right now. There really isn't much risk at the top of the capital structure in these RMBS deals. I think ABS CDO issuance is going to be higher than it was last year, and I think people are targeting a 65% to 70% residential [overall RMBS concentration within the CDO sector].
ASR: How do you expect synthetics to change the face of the market?
AP: It already has. ABS synthetic buckets are increasingly taking away the artificial demand, or satisfying the artificial demand, depending on the way you look at it. I think you're going to find less stress on people trying to just chase assets. I think what happens with the CDS market ... [is that] people can put trades on closer to intrinsic value levels than technical demand levels, and I think the market has begun to accept CDS as more of a viable asset class in and of itself.
ASR: Do you expect overall issuance volume in the U.S. CDO market to trend down or up this year from 2005?
AP: Issuance is trending up. All predictions are that we should see issuance around $200 billion this year, up from $155 billion in 2005.
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