European collateralized debt obligation bankers are laboring to wrap up deals before year-end, as market experts warn only a finite number of deals in the bulging pipeline will get done. Market participants attribute the difficult market to several factors: banks having to sell down large secondary positions, monoline wrap providers curtailing policy writing activities and investors becoming even more risk averse.
A conservative estimate by CDO bankers and analysts puts at least 10 deals in the pipeline. A back-of-the-envelope calculation by BondWeek, based on research published by Dresdner Kleinwort Wasserstein, puts roughly E13 billion worth of deals in the pipeline. One CDO expert estimates the European market can absorb about E5-6 billion more of CDO deals. "Investment banks have deals they must get done by year-end and are getting nervous," says a CDO specialist at a monoline wrap provider.
The CDO specialist says banks are sitting with piles of secondary paper--tranches of deals they were not able to sell--on their books and bank risk managers are telling them they have to sell down these positions, making it even more difficult to price deals in the primary market. "With so many investors nursing difficult positions and bits of paper from secondary inventories competing for air time, the window for getting deals done is closing," says Nick Morgan, head of ABS and CDO syndicate at DrKW in London.
Another CDO banker at the London branch of a U.S. bank, says the withdrawal of the monolines from the CDO business will have a big impact on investment banks' ability to bring deals to market. Some monoline wrap providers (financial assurers) such as Financial Security Assurance have pulled back from writing policies on CDOs. And, Ambac Assurance Corp. has suspended writing credit protection on some types of synthetic deals. Financial assurers provide monoline wraps from super senior tranches on synthetic deals as well as secondary wraps done privately for CDO investors seeking extra protection. Secondary wraps--another kind of credit enhancement--are done for both cash and synthetic deals.
DrKW's Morgan says the year-end wind down is a "usual occurrence," but notes the CDO market's closure is coming a bit earlier this year. "Deals will have to do something to be put on top of the in-tray," he says. Pricing, quality of structuring and competence of managers are going to be the key to getting deals off the ground by year-end. "Investors have to be selective and differentiate the better deals," he says.
Bankers say there is some room for a few balance sheet trades, but that CDOs backed by ABS paper, such as residential mortgage-backed securities and consumer loans, are seeing the most demand. Deals that urgently need to be priced this year, maybe able to do so if issuers compromise on pricing, say bankers.
Demand for CDOs should pick up once corporate credits begin to improve, hopefully next year, they add. However, a war in Iraq could make conditions even worse. "Iraq is spooking the market. Everyone's nervous and looking for a reason not to buy," says one.