Market participants are drumming their fingers and waiting for guidance on if - or how much - negative performance in the subprime mortgage sector will affect CDO performance.
For structured finance CDOs, trying to place an overarching estimate on that burning question is no easy task, if not impossible. After all, such an analysis requires not only two sets of structural attributes - of both the CDO and underlying RMBS collateral - but also loan-level analysis, such as FICO score, geographic location and documentation.
So far, however, there is at least one consensus that continues to rear its head: Even though they are arguably the largest holders of mezzanine subprime credit risk, newer vintage SF CDOs are unlikely to see any material losses from turbulence in the sector for several years.
Fitch Ratings late last week held a Webcast aimed at outlining CDO exposure to subprime collateral, and both Fitch and Moody's Investors Service recently released reports outlining subprime risk inherent in CDOs backed by trust- preferred securities. (In the case of TruPS CDOs, both rating agencies seemed to conclude the risk of a subprime-led performance deterioration is minimal.)
While volatile spread levels throughout the synthetic and cash HEL and CDO sectors have a number of CDO noteholders nervous, Fitch analysts and others pointed out that fundamental HEL performance will ultimately conclude the story of how these holders' hefty exposure in SF CDOs will pan out.
"[CDOs] have the latitude to ride out market volatility in pricing, but if the cash flow suffers, it will begin to impact the CDO vehicles themselves," said Chris Flanagan, head of global structured finance research at JPMorgan Securities last Monday during a conference call on the subprime mortgage market.
Flanagan added what CDO managers have been pointing out for quite some time: that a manager's ability to select collateral will be a key determinant in future deal performance. "Generally speaking, we are underweight the ABS CDO sector, but we do understand that ABS CDO managers will be able to differentiate themselves," he said.
So while investors wait for performance to pan out, perhaps those feeling the most sting right now are those who were in the process of warehousing assets for new structured finance CDOs, a number of which were liquidated at a loss because of undesirable collateral characteristics, market sources said.
On a positive note, liquidity is beginning to open up for new 2007 collateral, which is considered to be somewhat cleansed of the underwriting faults and marginal originators that led to the now poorly performing 2006 vintage.
"What we've seen so far is that a lot of the collateral that was being warehoused for CDOs that we were expecting to see in the early half of 2007 has been moved to other sources," said Kevin Kendra, a managing director at Fitch, speaking during the Webcast. "We have also heard that there are a number of warehouses out there willing to provide funding to CDO managers who will ramp up clean collateral."
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