Even though spreads for CDOs backed by structured finance and high yield loan collateral continue cranking tighter, the return is "more than fair" in the triple-B rated tranches of those deals, where tightening has not kept pace with higher-rated tranches, according to a recent UBS report. For example, while triple-A and double-A rated structured finance CDOs are at their tightest-ever spread levels, single-A and triple-B rated tranches are 20 and 65 basis points wider than historic tights, respectively, according to UBS.
And investing in those assets is a better bet than placing money in similar yielding corporate bond portfolios, they advise.
"In making our judgments, we don't claim that [triple-B] CDOs absolutely won't be downgraded or won't default. We just think that double-B rated corporate bond portfolios will precede them and outdo them in downgrade and default," analysts wrote in the investment bank's CDO Insight.
Average spreads on triple-B rated tranches of U.S. high-yield-backed CLOs were at 165 basis points over Libor, while triple-B rated structured finance CDO tranches averaged 285 basis points over Libor. Spreads on those tranches remained unchanged at the year's tightest levels for the past two weeks, according to JPMorgan Securities, compared with 25 and 30 basis points over Libor for triple-A tranches of the structures.
With both pairs offering the same yield, UBS analysts are recommending triple-B rated collateralized loan obligations instead of double-B plus corporate bonds, and triple-B rated structured finance CDOs over double-B corporate bonds. The rationale: corporate bonds are bound to perform worse in an economic downturn than CLOs and structured finance CDOs - the structures of which will offer more liquidity than a bond in a rising rate environment.
Analysts from both New York investment bank Bear Stearns and rating agency S&P this week said in conference calls that ABS issued by the automakers are not likely to perform poorly because of problems at the parent companies.
Not to neglect history, UBS admitted it is possible to get triple-B CDO performance horribly wrong.
ABS CDOs received the highest number of downgrades among other asset classes in the first quarter, according to S&P. Triple-B tranches from less diversified CDOs with a high concentration of real estate collateral have seen a 6% downgrade rate to below single-B, according to UBS.
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