Market-value CDOs have been creeping their way back into vogue over the past year and a half, and the rebound experienced in 2004 could signal an emerging trend if market conditions remain stable, according to Standard & Poor's. S&P attributes the recent increase to the overall stability of the bank-loan market, as market value CDOs tend to be comprised significantly of bank loans for liquidity purposes.

Market value CDOs look a little different than they did before 2003. In the past eighteen months they have contained more bank loans as portfolio assets than ever before, as much as 40% to 80% in the post 2003 era, up from 20% to 60% in the pre-2003 period. Credit default swaps and shorts, non-existent in pre-2003 market value CDOs, now make up 5% to 15% of the securities. Private equity has virtually disappeared from portfolios, and S&P attributes that trend to the fact that collateral mangers of post-2003 market value CDOs are more focused toward liquidity, and private equity tends to be less liquid than other collateral.

Market value CDO capital structures have also changed significantly in their most recent iterations. The senior-most tranches of the capital structure, which include revolving notes and term notes, are rated "AAA" versus "AA" and as a result, require increased enhancement. Modern market value CDOs also have a small number of mezzanine tranches now, as investors have been requesting predominantly investment-grade ratings.

S&P rated three market value CDOs in 2004, up from one the year before and zero in 2002, and the rating agency expects to rate additional ones this year from both repeat and new market value CDO managers.

Copyright 2005 Thomson Media Inc. All Rights Reserved.

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