Bid-offer spreads in the collateralized debt obligation market are narrowing as liquidity increases. On senior bonds, bid-offer spreads were trading as tight as two ticks, or 2/32, apart late last week on so-called clean, highly rated paper, according to traders. This is in from four ticks as recently as the end of last year, as traders say the dealer community is bidding up CDO paper because it tends to offer more yield than the underlying markets. The secondary market is also increasingly the focus of dealers and investors, leading to narrower trading gaps, because tight spreads in collateral markets are making it difficult for managers to structure transactions, leading to limited supply on the primary side.
And, within the CDO world, the trend is that junior and subordinate bonds are also becoming more liquid and are beginning to pop up more frequently on bid lists, according to a report from Bear Stearns. Previously, the bid lists consisted mostly of only senior classes. "Liquidity in mezzanine classes has improved considerably of late," says one CDO. While bid lists of junior classes are much smaller than senior lists, because there's less collateral to sell, traders report seeing lists containing 5-10 bonds and totaling roughly $50 million of mezzanine paper--which would have been unheard of a few months back. "People are reaching out for mezz because there's not a lot out there and they are looking for yield," explains another trader.