The market for collateralized bond obligations of investment-grade corporates is all but dead, according to various buy- and sell-side market participants. Buy-siders Aladdin Capital Holdings and Triton Group LLC have reportedly shelved plans in recent weeks to issue cashflow CDOs backed by corporate bonds, as rising prices have eroded the arbitrage between the underlying bond prices and CDO liabilities, according to market players. These price increases have made it all but impossible for collateral managers to structure deals that would be both attractive to outside investors and profitable for themselves. "It's a real indication the CDO market is evolving," says one participant, who notes that investment-grade corporate bonds were some of the first securities to be collateralized in a market that is now focusing on derivative, loan and structured finance paper.
Stamford, Conn,-based Aladdin and New York-based Triton were independently planning to issue $300 million CDOs of underlying investment-grade corporate bonds, apparently on expectations that corporate bonds prices would fall and create arbitrage opportunities. But several CDO market professionals say the two firms have quietly pulled the deals because the corporate bond market shows no signs of weakening and the economy appears to be picking up. And, with that outlook, the buy-siders could not entice investors to participate at rates where the collateral managers could buy corporate bonds and still maintain a profit off the CDO issue. George Marshman, cio at Aladdin, and Simon Mikhailovich, managing partner at Triton, did not return calls. Questions over Triton's future given recent departures of key managers (BW, 4/21) are also said to have contributed to the postponement.
A Banc of America Securities index of 100 investment-grade corporates has tightened from mid-market levels of 140 basis points over Treasuries in March to roughly 115 basis points last week. Of course, managers would get even less if they bid for the bonds, and the minimum threshold to structure a profitable deal based on this index is around 85 basis points.
"The way investment-grade deals are going to get done is as synthetics," says Drew Dickey, managing director at veteran CDO manager David L. Babson. He adds, "Cash, in whole or in part, would be an uphill battle." Analysts say synthetics are easier to structure because managers do not have to acquire all of the underlying collateral, as they do in cashflow deals, and because of the vastness of the default-swap market. And bespoke, or single-tranche, CDOs are also hot because "it's a lot easier to place one tranche than to place six or seven tranches," according to another sell-sider.
The scuttled deals were the only two in the CDO market's $5 billion pipeline to be comprised of underlying corporate bonds, and bankers say no other cashflow deals will be marketed in the near future. "Unless spreads move way out, there's no way these deals will ever get done again," predicts one sell-sider.