The amount of risk being shifted via the collateralized debt obligation market has halved this quarter, but the number of deals has rocketed, according to Moody's Investors Service. Moody's rated 154 CDOs in Europe during the first half of the year compared with 83 in the same period last year. In contrast, the size of the rated tranches fell to EUR18 billion (USD19.7 billion) from EUR43 billion, according to Ebo Coleman, senior credit officer in London.
A major reason for this is the move away from full capital structures, in which the super senior risk is sold, toward single-tranche deals. This move is largely driven by the increased sophistication of correlation trading and forthcoming changes in the regulatory framework. The motivation for CDOs used to be for the holders of the reference portfolio to get capital relief through selling the super senior tranche. But with Basel 2 just around the corner motivations have shifted to investor demand, explained Rick Watson, head of ABS and CDOs at HSBC in London. The new Basel Capital Adequacy Accord is due to be introduced in 2007. In the first half of 2003 balance sheet deals accounted for only 6% of deals, whereas they made up 27% in the same period last year, according to Moody's statistics.
Another reason why structurers have stopped transferring the super senior tranche is the price has rocketed. "Back in early 2001 protection was less than 10 basis points. Now there are few trades but you would be lucky to get it done for less than 20bps," said Coleman. The monoline insurers withdrawing from the market, or changing their credit policies, is the reason why spreads have pushed out (DW, 9/22).
The reduction in credit arbitrage opportunities also has diminished investor appetite. INVESCO, BlackRock, Barclays Global Investors and Blackstone all delayed CDOs earlier this year (DW, 1/9). Andrew Feachem, structured credit marketer at ABN AMRO in London, said, "One of the reasons the arbitrage is not there is there is a large pipeline of full capital structure deals waiting to print and as soon as the market widens it will get hit." One of the consequences of this is that more deals are being referenced to asset-backed securities, where the ratings and spreads have been more stable.
Huxley Somerville, head of credit derivatives at Fitch Ratings in London, said it has also started to see more single-tranche deals and fewer super senior tranches. Standard & Poor's is witnessing a similar trend, according to a firm official.
