Strong CDO market next year, says S&P

The pipeline of collateralised debt obligation (CDO) deals remains “extremely strong”, promising a busy start to 2004, especially for single-tranche, leveraged loan and CDOs of asset-backed securities (ABS) transactions, said credit rating agency Standard & Poor’s (S&P).

“This reflects the rapid growth of the European CDO market in 2003, driven primarily by an increase in synthetic transactions,” said Katrien van Acoleyen, a London-based director in S&P’s structured finance ratings group.

Of all the CDOs rated in 2003 by S&P, 93% were synthetic, up from 85% in 2002. “The increased familiarity of investors with synthetic technology, the lack of liquidity in the cash market, the flexibility offered by the synthetic product and greater standardisation should all contribute to the further growth and dominance of synthetic CDOs next year,” said van Acoleyen.

The rating agency expects the improved rating performance of synthetic CDOs in 2003 to continue into 2004. At the end of November, 84 classes of synthetic CDOs were downgraded, representing 18% of classes outstanding at the beginning of the year. The corresponding 2002 figure was 28%.

“As well as reduced credit migration in the underlying corporates and increased seasoning of transactions, both synthetic and cash transactions are also likely to benefit from the trend toward more structured finance securities in the underlying portfolios, and hence more stable underlying ratings,” said van Acoleyen.

S&P said it expects to see at least 15 arbitrage CDOs of ABS next year. There were nine such deals this year. “A key driver of potential growth will be the ability to source assets, especially mezzanine tranches that provide greater arbitrage opportunities,” said S&P director Juan-Carlos Martorell.

Among balance-sheet transactions, S&P said that small and medium-sized enterprise assets have been popular this year. "We expect to see more of these transactions in 2004," said S&P director Hervé-Pierre Flammier. “One factor which could help drive this market is the continuing postponement of the Basel II initiative, which may lead to an increase in balance-sheet transactions as sponsors can still receive economic and/or capital relief.”