As the U.S. CDO sector rounds the corner into the latter half of 2006, market participants are taking time to reflect on some of the trends - from collateral spreads that continue to grind tighter to the increasing use of synthetics - that continue to mold this market. ABS CDO issuance in the first half of the year ballooned to more than $126 billion, almost double the $64.5 billion reached during the same time period last year, according to data maintained by Thomson Financial.
While the U.S. housing market continued to feed the so-called CDO machine - and vice versa - managers began looking to new strategies in order to increase leverage and/or maintain arbitrage. Alternatively, a number of market participants are anticipating more CDO structures to incorporate multiple credit views in order to ensure good positioning through what is a widely expected shift in the currently benign credit cycle.
Opportunistic type structures, such as market value deals that incorporate a bucket of short credits, are expected to become more prevalent. For example, State Street Global Advisors was arguably the first to bring to the market a new twist to the sector called the long/short CDO last fall. The deal, Diogenes CDO I, incorporated long cash baskets with short CDS of single names and corporate indices. It was closely followed by Trust Company of the West's Dutch Hill Funding deal. Other trends expected in the market include a wider mixing of floating and fixed rate collateral, as well as staggered maturity strategies, as first seen with Fortis Bank's Regatta CDO. New structures are expected to incorporate more flexibility for managers to trade in and out of credits, as well as more mark-to-market triggers that will allow investors other options in underperforming deals.
Synthetics, orphans steal the show
Since the International Swaps and Derivatives Association published standardized HEL ABS credit default swap confirms in June 2005, liquidity in the market has grown exponentially. Cash CDOs have increased their allowances for synthetics from 5% to 10% to a fairly standard 20% to 40% allotment, JPMorgan Securities analysts noted last week. In fact, it has become rare to find a cash CDO transaction without and allotment for the synthetic notes. This has given managers more flexibility and a much broader range of collateral to ramp up with.
In another spread gaining move, some collateral mangers in the last six months sought more spread friendly asset types - deemed "orphan assets" by JPMorgan -with which to sprinkle into part, or all, of their portfolios. Market participants are anticipating CDO buckets to continue to exist, and possibly expand, within U.S. CDOs, as well as double-B home equities. Perhaps one of the most interesting new-collateral structures to hit the market in recent months was the first-ever managed collateralized commodity obligation (ASR, 06/12/06), which is managed by TCW and was brought by Barclays Capital. The CDO is backed by so-called commodity trigger swaps, and, came to the market with a high "orphan asset" premium.
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