The last thing ABS CDO managers want is to be compared to the TABX. For them, it is like being on par with a disowned relative. And one can only imagine how recent speculation that the price of new issue ABS CDO notes might fall in line with those of the TABX has further strained this relationship.
But alas, incentives can sometimes turn around even the most estranged relationships. Some CDO managers have decided to use the market's decision to price the TABX at a relative discount to their advantage.
A handful of managers are interested in gaining exposure to the TABX either through credit-linked notes or swaps, according to recent proposals before rating agencies. Adding a basket for TABX exposure in these cases would boost portfolio average spread - although it should be noted that not all CDO managers think the reward is worth the risk.
The tricky part to modeling a portion of that risk, as Moody's Investors Service points out, brings us back to that sensitive topic of exactly how correlated the two structures are. More pressingly, this leads us to question how synthetically induced interbreeding is affecting not only a given CDO's asset correlation but also correlation within the ABS CDO sector itself. (Moody's does not formally address how the structure of the TABX - and not just its underlying collateral - would implicate performance of CDOs exposed to it.)
"I think correlation is probably the primary concern. Other than that, you can think about it as a bespoke CDO of ABS tranche in the CDO," says Yvonne Fu, team managing director at the rating agency.
The rating agency said in a report released last week that it needs to update its correlation assumptions for ABS CDOs to account for the fact that managers are increasingly sourcing the same collateral through the use of synthetics. Correlation is even more dramatic as ABX, and now TABX exposure may be creeping into portfolios.
Moody's is working to update its inter-CDO correlation assumptions, but, in the meantime, said it may use a so-called look-through approach to gauging ABS CDO correlation in the initial rating process. This means analysts may look at collateral backing the CDOs that reside in some CDO buckets. The approach is admittedly challenging, as ABS CDO collateral is rarely static.
Moody's also noted that managers need to define TABX exposure as such in order to ensure intra-CDO asset correlation assumptions are correct. For example, if CDO managers wanted to use credit-linked notes to reference the TABX, they would need to define correlation between those notes, as well as between any other related single name or index exposure within the CDO, Moody's explains.
The rating agency is currently limiting aggregate CDO exposure to the TABX and ABX to 2% for high-grade deals and 5% for mezzanine deals.
The exposure to any ABX vintage should not exceed 2%. A 2% exposure to the TABX would imply a 1% exposure to the ABX 06-2 and ABX 07-1.
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