Synthetic collateralized debt obligation volumes rocketed from European issuers last year, while the number of cash flow deals remained, at best, flat, according to BW sister publication Derivatives Week. End-of-year figures obtained by DW, due to be published by the rating agencies in the coming weeks, show the number of synthetic CDOs increasing up to threefold, whereas cash-flow deals have either stagnated or fallen. "What I thought might take five or six years happened in two years. The speed surprised me," said Ebo Coleman, v.p. and senior credit officer at Moody's Investors Service in London.
Standard & Poor's rated 60 synthetic CDOs and 21 cash-flow deals in 2002 versus 17 synthetic and 24 cash-flow CDOs in 2001. Moody's rated 158 synthetic deals and in 2002 compared with 107 synthetic CDOs the previous year. It rated 26 cash CDOs in both years. Standard & Poor's figures only include publicly placed transactions, so the proportion of synthetic CDOs is likely to be even higher as more private deals are synthetic.
Originators of CDOs in Europe are also increasingly separating two of the primary functions of securitization: to raise funding and remove risk from the balance sheet. This process is resulting in more synthetic deals, according to Darren Smith, co-head of CDOs at Dresdner Kleinwort Wasserstein in London. The European CDO market is still largely driven by banks wanting to reduce their credit risk and it does not make sense for these entities to issue a cash-flow deal in which they get funding at 60-70 basis points over LIBOR when they can issue plain-vanilla debt at 10 basis points over LIBOR. In contrast, the U.S. market, where most deals are still cash securitizations, is dominated by asset managers, which want to issue funded deals in order to increase their assets under management. An official at Moody's estimated that about 30% of CDOs in the U.S. are synthetic.
The relatively small size of the European debt market is another reason the rating agencies are seeing more synthetic deals in Europe, according to Stroma Finston, director in the European structured finance ratings group at S&P in London. The size, and fact that it is dominated by telecom debt, means it is hard for CDO structurers to get enough diversity in European deals if they are referenced only to European bond portfolios.