Structurers of European collateralized debt obligations are including more safeguards to protect against deterioration in the underlying credit pools, according to structured finance and asset-backed bankers. Structurers have taken a variety of steps, including further diversifying underlying credits, increasing the use of credit-default swaps and adding cashflow diversion tests.
"Given weak performance of some static CDOs many European CDO investors now request protection for senior tranches through cashflow diversion tests and covenants common to U.S. CDO structures. There is growing demand for managed CDOs, although anecdotal evidence from the U.S. suggests that not all managers will indeed outperform static pools," said Ra Sharma, global head of structured credit syndicate at BNP Paribas. Frederic Drevon, managing director at Moody's Investors Service, said he is also seeing more managed deals and that managers are not leveraging as aggressively as in the past. "They're managing the transaction, not being managed by the transaction," he said.
Amany Attia, managing director of structured finance at Lehman Brothers in London, said, "we are constantly refining structures and continue to look at ways which provide investors with different protection." Investors have been more adamant about safeguards after there was a significant uptick in CDO downgrades---20 in the first quarter this year versus 46 in total last year--brought about by recent corporate credit deterioration.
Mitchell Lench, analyst at Fitch Ratings in London, said he is seeing more safeguards included in new CDOs. "The biggest issue, in terms of new safeguards is increasing the diversification in credit-default swap portfolios. Where there may have been 70 to 100 obligors in the reference pool, now there can be up to 300," he explained.
