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Derivatives

Puttable Money Market Notes Gain Role In CDOs

Collateralized debt obligation issuers have started to structure true sale CDOs that feature puttable money market notes. As well as reducing funding costs, issuing short-term notes to fund CDOs has the added advantage of opening up the approximately USD2 trillion U.S. money market as a source of financing. Major derivatives houses, includingJPMorgan , are planning to bring such deals to the market, according to an official at the firm. Darren Esser, associate director at Standard & Poor's in New York, said the ratings agency is getting more and more enquiries from potential issuers, many of which would be debutants.

CDOs are typically funded at 5-10 year rates. Issuing notes against senior tranches allows structurers to take advantage of lower short-term funding. Liquidity risk from this is then eliminated via the put. Issuers of CDOs funded with short-term paper--that lack this feature--run the risk that the notes cannot be resold and thus principal and interest payments due on the maturing notes would not be met.

The funding advantages of this structure are illustrated by a CDO that Putnam Investment Management issued in June. In the deal, senior tranches in the CDO were funded via three-month money market AAA notes that paid LIBOR plus 4 basis points and three-year AAA notes that offered LIBOR plus 32bps, according to JPMorgan research. Conversely, a typical CDO is usually funded at around LIBOR plus 50-60 basis points, noted Henry Albulescu, managing director in global CDOs at S&P.

Albulescu explained puts have been used to hedge against liquidity risk in student loan securitizations for several years, but this is a new application to CDOs.

Putnam is readying its third such deal, a USD560 million structure investing in real estate, dubbed Putman Structured Products CDO 2003-1. The deal will issue notes from its senior tranches. Sinead Martin, spokeswoman at Putnam in Boston, did not return calls.

 

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