MIAMI - Shaken by diminished investor demand and in some cases significant losses, but heartened by improving market conditions, CDO issuers are cautiously slipping quarters back into the so-called CDO machine that once fueled much of the subprime mortgage sector's most recent rise.
Participants in last week's Information Management Network Spring ABS 2007 conference said they anticipate ABS CDO issuance will begin picking up steam by the end of the summer, thanks to cleaner HEL collateral, structural tweaks and renewed investor demand.
In the meantime, issuers are focusing on "super" high-grade deals, static structures, CDO squared transactions and, increasingly, structured investment vehicles.
Some are even considering moving in the direction of multisector CDOs - adding a broader range of collateral as they wait out the rash of poor performance currently enveloping the subprime sector. "People have been focusing on how to get away from subprime," said Sud Subrahmanyan, an executive director at JPMorgan Securities.
Structural changes
In what has become an increasingly opaque pricing atmosphere, market sources have speculated for some time that deals are not actually being sold at the prices they print at, but instead being handed over to investors at deep discounts, particularly at the lower end of the capital structure. To help drum up interest in subordinate CDO notes, some arrangers are increasing subordination, and ratings, at the lower end of the capital structure.
Also, arrangers are making tweaks such as altering payment dates and switching to pro rata pay structures from sequential pay structures. Several issuers talked about including provisions within deals that would allow the collateral manager more flexibility to increase or decrease pool quality, based on varying levels of diversity, for example.
Mizuho Securities, for one, is planning on including such a matrix in its next CDO deal, said Mizuho vice president Gwen Snorteland. Such a matrix would allow a collateral manager to increase correlation as long as it was in line with a compensatory increase in collateral quality, for example, or alternatively allow
for less correlation and lower
rated collateral.
Multisector flashbacks?
"If you look at the cycles, commercial real estate is not correlated with residential real estate. Commercial real estate could be a good way to diversify an ABS CDO," said Steven Todd, a vice president at Wachovia Capital Markets.
However, for many market players, transitioning toward diversification brings back bad memories of poorly performing multisector CDOs, which were riddled with defunct aircraft lease and manufactured housing collateral.
"You don't want to roll into the next credit problem through diversification," said Christopher Flanagan, a managing director and head of global structured finance research at JPMorgan Securities. "Your best bet is just to find quality collateral."
Diversification for diversification's sake, some said, was bound to bring challenges for CDO managers who may not be as experienced dealing with multiple collateral types as they would be with a single sector such as RMBS. "While diversification is great for rating agency models, really, quality of collateral is more important," said Alex Wei, senior vice president and head of structured credit investments at Delaware Investments.
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