Synthetic collateralized debt obligations using investment grade names as referencing collateral are the structures most vulnerable to fallout from Enron's tumble, according to ratings agencies. Managers of cash flow arbitrage deals, ironically, by and large will avoid being hurt by Enron because they invest in "risky" high-yield bank debt and bonds. Enron was an investment-grade name when its obligations were referenced in default swaps in many synthetic CDOs, and Nik Khakee, analyst at Standard & Poor's, said those deals can expect to feel some pain.
But the pain should not prove to be unbearable. The synthetic CDOs own a credit derivative on Enron's obligation to pay off bonds and loans, so noteholders essentially own the credit and are paid a return to take on exposure to the name. Analysts last week said the hit from Enron will effectively eat into the credit protection cushion on the deals. In doing so, it eats from the bottom up, so the most junior tranches become more exposed as the cushion erodes.
Enron's benchmark status in the credit derivatives market put it in a lot of deals. At the end of last week, S&P and Fitch both took ratings actions on several synthetic deals as the effects of Enron's default became apparent (see box for the list of deals). It could not be determined by press time if Moody's Investors Service will be taking similar action.
"The amount of credit protection available to noteholders is less than it was before," explained Roger Merritt, analyst at Fitch. He said typical investors in such deals are insurance companies and foreign banks, many of which are Asian investors. Fitch estimates that these CDOs have roughly $181 million of Enron exposure primarily through credit default swaps in their portfolios aggregating $19.5 billion. Companies that last week announced exposure to the company include Aegon NV, Fortis, AXA, and John Hancock.
Scott Hartz, v.p. and portfolio manager at John Hancock, said the company did not have exposure to Enron through synthetic CDO deals. Officials at Aegon did not return calls. Gerard-Jan Van Berckel, investor relations at Fortis, said he could not discuss CDOs specifically, but said exposure to the company is via many channels. Tom Swank, cio of Security Benefit Life, said the company was in the process of assessing its exposure through structured finance products.
In addition to the static pool synthetic deals, many institutions --including Bank of America -- transferred a portion of their lending exposure to Enron to the capital markets in the form of balance sheet deals according to Fitch and S&P.