The pipeline for collateralized debt obligations backed by emerging market debt is showing some signs of life, according to rating agency and sell-side CDO professionals. They said there are a handful of proposals on the table for vehicles that will collateralize emerging market sovereign bonds or include large buckets for the sector, in what would be the first such deals of this kind in years.
Emerging market credits are attractive candidates for inclusion in CDOs now because they have not tightened as much as other underlying securities, such as leveraged loans and asset-backeds, according to one analyst. "People are looking for yield and the idea is if the [economic] recovery is truly global, there's a window of opportunity to do these deals" before spreads tighten and erase any arbitrage, said one rating agency official. He declined to name specific transactions except to say they are in the proposal stage and are being proffered by managers with experience in emerging markets.
Fourteen deals backed primarily by emerging market debt have been sold since 1996, with most of those done before the 1998 Russian debt default having imploded. That put a damper on the use of emerging debt in future CDOs, even though those that were done were stringent in their asset selection and performed well, he said.
"Because it had such a horrible track record, that allowed those few CDOs that were done to perform well," said one analyst. He said it makes sense that emerging market debt is being revisited: "Managers are looking for anything; the spreads on U.S. loans have been bid down and you need something to make the arbitrage work for the equity."