The unprecedented volatility in the collateralized debt obligation market should stabilize this year as originators continue to put more-stable asset classes in the repackagings and avoid assets such as high-yield and emerging market bonds, according to a panel of CDO sell-siders and an investor at the American Securitization Conference in Scottsdale, Ariz., last week. Anthony Thompson, head of CDO research at Deutsche Bank, noted that CDOs are in essence a levered bet on credit stability and fared poorly in times of weaker credit. "The potential for a dramatic drift is much, much higher," he said, referring to the propensity for a rating change in CDOs. As a result, Thomspon said he expects to see the continued presence of deals coming to market with a senior/subordinate structure to provide credit enhancement and a monoline wrap to guarantee certain classes. In other parts of the structured finance market, deals tend to come with one or the other method of protection, but not both.
Nevertheless, despite the volatility, which is causing even triple-A classes to have their ratings cut, the CDO market should continue to grow as structures improve and liquidity increases, drawing more investors. "Now there's an exit option," Sunita Ganapati, head of CDO research at Lehman Brothers, remarked on the panel, referring to increasing liquidity.
Panelists also questioned the motivations behind single-tranche CDOs, which are increasing in popularity, particularly in Europe. "If we invest in single-tranche CDOs are we investing in risk the Street or someone else doesn't want," asked Sanjeev Handa, head of the $9 billion asset-backed portfolio at TIAA-CREF. Thompson answered that yes, investors are to an extent buying into risk that the seller either doesn't want to hold or has too much of.