New issuance in the U.S. CDO market remains dormant amid continued ratings instability. But the center of gravity seems to be moving east for CDOs as an increasing number of transactions are popping up overseas, particularly synthetic structures.
Across the pond, Calyon is arranging a E100 million ($142 million) synthetic CDO to be fully managed by M&G Investment Management under the name Ocelot III. The Bank of New York in London will be the trustee on the deal. The transaction will reference corporations, including long positions on 135 unequally weighted names with a 10% bucket to buy short protection on corporate names, according to a presale report from Moody's Investors Service. The highest concentration of names in the portfolio is expected to be in banking, followed by insurance, oil and gas, telecommunications, chemicals, plastics and rubber, and utilities. The majority of these names will come from the U.S. and Western Europe, Standard & Poor's said in a presale report. The notes will pay a quarterly coupon of three-month Euribor plus a margin, S&P said. The transaction is set to close this month.
Another synthetic CDO deal launching overseas comes from London-based New Bond Street Asset Management, according to a market source. The deal is the latest in the firm's Piccadilly series and will reference 120 companies. Italian investment bank UniCredit is arranging the transaction, which is expected to exceed 150 million and close in November, a source said. Calls to New Bond Street and UniCredit were not returned by press time.
Quiet On the Western Front
Meanwhile, the already stagnant U.S. ABS CDO market has been blanketed by yet another round of downgrades, confirming expectations of additional collateral losses in the sector. One market participant even questioned whether this was the end of the ABS CDO market altogether.
On the heels of Moody's recent downgrade of $33.4 billion of securities issued in 2006 that are backed by first-lien subprime mortgages, Standard & Poor's last week lowered the ratings on 402 first-lien U.S. subprime RMBS classes, totaling $4.6 billion, from the first quarter through the third quarter of 2005.
Last week, S&P also downgraded 1713 classes of U.S. RMBS backed by first-lien subprime mortgage loans, first-lien Alt-A loans, and closed-end second liens that were issued between Jan. 1, 2007 and June 30, 2007. The downgrades amounted to $23.35 billion. Thirty-nine AAA' rated securities were slashed, though no rating waslowered below A'.
In addition, S&P placed on CreditWatch negative the ratings on 646 other classes of U.S. RMBS backed by first-lien subprime loans and first-lien Alt-A loans issued during the same period, representing $3.3 billion.
Some segments of the CDO market, however, continue to see interest. "As long as people have money to invest, there will be structures to invest in," said Mark Ellenberg, partner in the financial restructuring group at Cadwalader, Wickersham and Taft.
Deals currently hanging on include emerging market CDOs, CRE CDOs and straightforward managed cash-flow CLOs, according to a CDO market participant, who felt that the simpler structures were beneficial to the shaky market. "Vanilla is a good flavor," another market participant added, in reference to the potential for more transparent vehicles in the future.
Indeed, with lack of trust in the rating agencies, investors appear to want more straightforward, "analyzable" structures that they can decode themselves, instead of relying on the rating agencies for due diligence. "When times were good, you took comfort in the triple-A' rating, even if the transactions were a bit more complex. Now a triple-A' rating is getting more scrutiny," said Richard Schetman, partner in the capital markets group at Cadwalader.
For now, deals that have been shelved include ABS CDOs and high-grade structured finance CDOs with 1% equity, according to market sources, who had little to no expectations of a comeback anytime soon, especially in light of the continued RMBS downgrades.
High-grade structured finance CDOs hit by previous downgrades were made up almost entirely of SIV-lite or market-value transactions, such as Solent Capital Partner's Mainsail transaction, a SIV-lite structure that was forced to unwind last month, and TCW Asset Management's Westways deal, a market-value CDO that also liquidated last month, JPMorgan noted in a recent report. The bank noted that high-grade structured finance market-value CDOs have been downgraded 12 notches on average.
And analysts expected more bad news to come. "We reiterate that CDO downgrades have just begun, in number and severity," the JPMorgan report said, addressing the possibility that the market could see AAAs' and AAs' fall to the BBB' and BB' area, and single-As' through BBs' fall to the single-B' to CCC' area. Indeed, if the housing downturn exceeds the 10.4% peak-to-trough HPA assumed by Moody's, ratings would have to be re-evaluated, the JPMorgan analysts said, which they thought likely.
Others agreed. How can anyone expect "there is a low probability that cumulative house price declines will not exceed 10.4% from peak-to-trough, [when they have] already declined by 3.9% through July, and 10.4% is set to be in striking distance by the end of the year," Christian Stracke, analyst at independent credit research firm CreditSights, said in a report. Even if Moody's revised assumption about the decline in house prices from peak-to-trough proves correct, he would still expect the market to continue to "put little faith in the Aaa' and Aa' ratings that depend so much on such a tenuous forecast."
Among the transactions hit hardest by agency downgrades thus far was Abacus 2007, arranged by ACA Management, which had 84% of its total RMBS collateral downgraded. Around the time of the downgrades, Laura Schwartz, who was senior managing director of ACA Capital and chief operating officer of ACA Management and was responsible for the company's CDO asset management platform, left the firm, according to market sources (see Whispers pg. 5).
Adams Square Funding I and II, arranged by Credit Suisse Alternative Capital, had 79% and 64% of its total RMBS collateral downgraded. Octonion CDO, arranged by Harding Advisory, had 80% of its RMBS collateral downgraded, and TABS 2006-5 and TABS 2006-6, arranged by Tricadia CDO Management, had 72% and 76% downgraded, respectively. All of the transactions were issued in the second half of 2006 or the first half of 2007.
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