Anumber of CDO investors right now are like penny-pinching shoppers waiting for after-Christmas bargains, according to one analyst. The problem though, is that Christmas Day - the date the real estate bubble may be pricked - is a moving target.
"You're not going to go out and buy a television set before Christmas when you know it's overpriced," said Mark Adelson, head of CDO research at Nomura Securities. "There are a fair amount of people sitting on cash right now, waiting for spreads to get wider, and arguably represent a better buy."
Triple A structured finance CDO tranches were unchanged last week, at roughly 30 basis points over Libor, two points tighter than the last time it changed in mid-April, according to sources.
While traders say they are finding some good buys in the secondary market on certain older vintage pockets, diversified structured-finance deals backed by aircraft-lease and manufactured housing assets, they are "few and far between," and new-issue pricing remains at historic tights. "We are all waiting on the edge of our seats," said one analyst.
But some think Christmas may not come this year.
Merrill Lynch last week lowered its year-end 10-year Treasury yield expectations to 3.8% from 4.4 %, following PIMPCO's Bill Gross, who forecast 3.25% 10-year Treasury yield at 4%, indicating a slowdown in Federal Open Market Committee tightening. The move would alleviate some of the stress associated with homeowners approaching reset dates on their adjustable-rate mortgages.
It could also continue fueling the real estate market, which some argue remains strong. Existing home sales rose 4.5% in April to a record-high 7.18 million units - 5.7% higher than year-ago levels, according to the National Association of Realtors.
"If the 10-year [Treasury] stays where it is, and we stay in the low four handle on yields - and, God willing, three handle - the engine will continue being fueled by the lower rate environment, and the effects of a bubble burst won't materialize," said Armand Pastine, managing director at Maxim Group. "The real issue is, if we don't have the volatility in rates, I don't think we're going to see the kind of impaired credit, delinquencies and defaults that people are talking about." Pastine added that premature spread widening could be a self-fulfilling prophecy for a real estate markets.
"I don't know why the concern now would be more acute than it was a year ago," said Douglas Lucas, director of CDO research at UBS. "Concern and complaint about the mortgage ABS I think really picked up steam in late 2003 and 2004, and all the rating agencies have now responded with tougher interest-rate stress tests on RMBS."
But PIMCO's Gross, citing the company's most recent investment outlook, stated that a stagnant rate environment and the potential for future rate reductions could cause institutional and retail investors in levered products to "become increasingly disenchanted with quarterly/annual returns," and that an "unwind of levered structures could take place even in the fact of continued economic growth, much like we've seen in recent weeks."
Nomura's Adelson said this month's Ford Motor Co. and General Motors Corp. corporate credit downgrades, "may have provided a wake-up call" that could trigger buyers to exercise more caution when investing in CDOs - to note peripheral conditions not found in a model that could impact performance, and that illiquidity in the older structured finance CDOs should become a "vivid lesson" of the complexity of those underlying assets, adding "where spreads are now, it's hard to look someone in the eye and tell them whether the security they are being offered is really attractive from a value perspective."
But Adelson was careful to point out that any of the housing bubbles, most notable in California, may not burst, but rather slowly exhale, and that the market may even defy expectations and continue appreciating for a number of years.
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