Nomura Fixed Income Research
Nomura Fixed Income Research
CDO/CDS Update 9/12/05
I. Commentary
U.S. CDS spreads tightened as the equity market rebounded and CDO-related hedging
activities led to protection selling. The 5-year DJ CDX.NA.IG tightened from 53.3 bps to 50.1 bps.
The 30-name high-volatility sub-index also finished tighter at 112.0 bps, compared to 119.3 bps in the
prior week. The DJ CDX.NA.HY index ended about 18 bps tighter at 362.7 bps. The 5/10-year curve
of the CDX index also flattened slightly. Global CDS index spreads also finished tighter.
The investment-grade and emerging market (EM) CDS indices will roll into new maturities on
September 20, while the high-yield index will be rolling on October 6, according to Markit. Starting
with the next week’s roll, the DJ CDX index will have a 35-name "crossover" index,1 similar to the
iTraxx Europe Crossover sub-index. The North American crossover index, called the DJ.CDX.NA.XO,
will include credits that are double-B rated by either or both of Moody’s and S&P, such as Ford Motor
Credit and GMAC. Other names that will be dropped form the current index include Eastman Kodak,
Kerr-McGee, Lear, Liberty Media and Maytag. Also, there is a talk of the European crossover index
and the Asian ex-Japan index being expanded from 35 to 40 and 30 to 50 credits, respectively.
The base correlations of the CDX.NA.IG Index declined by 3%-7%, with the 0%-3% tranche's base
correlation dropping below 10% to 7.3%. Similarly, base correlation of the iTraxx Europe index fell
across the board by 4%-9%. As a result, the base correlation curves flattened both in North America
and Europe. The 5-year tranche spreads also declined, except for the 0%-3% tranche where the
upfront payments moved up slightly. The move was partly related to the increased issuance of
leveraged super senior (LSS) tranches.
Also, with the roll date approaching, technical conditions may be developing for the “skew." After the
roll, by construction, the new index will likely have much lower spread dispersion than the old series.
It means less idiosyncratic risk, as opposed to systematic risk, which would effectively redistribute risk
from the equity tranche towards other tranches.
The U.S. speculative-grade default rate rose to 2.4% in August from 2.1% in July, according to
Moody's. 2 Last month, four U.S.-based issuers, Foamex, Foamex Capital, Anchor Glass
Container, and Fedders N.A., defaulted for a total of $1 billion of bonds. In 2005 to date, 18
corporate issuers have defaulted for $4.5 billion. The global default rate also edged up from 1.8% in
July to 2.0% in August, but the European default rate remained unchanged at 1.6%. Despite the
Contacts:
1
Michiko Whetten
Dow Jones Plans New Credit Index After Ford Downgrades, Bloomberg news (6 September 2005).
(212) 667-2338
2 Speculative-Grade Default Rate Edges Up to 2.0% in August, Moody's August Default Report (9 September
mwhetten@us.nomura.com
2005).
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uncertainty regarding impact of Hurricane Katrina, Moody's forecasts the speculative-grade default
rate to rise only moderately over next six to 12 months.
No rating actions have been taken on CRE CDOs in relation to Hurricane Katrina, as the rating
agencies scramble to assess the ultimate impact on various structured finance sectors. So far, Fitch
has identified 20 CDOs whose collateral pools include CMBS with exposures in the areas affected by
the hurricane.3 The largest exposure of 5.7% was found in a deal called SPA CBO, issued in 2000.
Fitch also found 18 CMBS deals with exposures to the region exceeding 5%. On the other hand,
S&P says 160 U.S. CMBS are likely affected, of which 12 deals may have material exposure to
Katrina.4
The U.S. CDO issuance is well ahead of last year's pace, according to Moody's.5 Through the first
half of 2005, the number of rated U.S. CDOs and issuance volume jumped 89% and 109%,
respectively, from a year ago. The new issuance accelerated particularly during the second quarter
of 2005, with 102 deals issued for an amount of $41 billion. By deal type, synthetic CDOs now
account for about a half in deal count, although by volume they represent about ¼ of all U.S. CDO
issuance. While resecuritization CDOs (i.e., structured finance CDOs) accounted for about slightly
above one third of the total issuance volume, CLOs made up about 25%.
By collateral backing the deals (including synthetics), structured debt represented 68% of the
aggregate collateral pool, followed by corporate bonds (26%) and loans (6%). In contrast, when
synthetic deals were excluded, structured debt and loans each accounted for about 45% of the
collateral pool. This is because many synthetic deals are now referencing structured finance assets.
Looking forward, Moody's reported that the indicator of relative "arbitrage" gain suggests that high-
yield CBOs may stage a comeback, while resecuritization appears to be becoming less attractive.
Also, the credit performance of the CDO sector remains favorable with the upgrade-to-downgrade
ratio increasing (35% for Q2 vs. 14% for Q1). Given the first half's brisk issuance pace, the rating
agency is currently projecting the full-year volume to nearly double from the 2004 level.
S&P assess the effect of concentrations of RMBS in CDOs.6 Earlier this year, some market
participants have become concerned about the prevalence of high RMBS concentrations in
structured finance (SF) CDOs. One advantage of including RMBS in CDOs is their much wider
spreads relative to other CDO collateral assets, such as existing CDO, ABS, and CMBS. Moreover,
RMBS has shown by far the best credit performance, with an upgrade-to-downgrade ratio of 13.8x
over the past year.
The report examined about 40 CDO deals that were issued between the second half of 2004 and
early 2005. RMBS accounted for over 50% of the collateral pool in 32 SF CDOs. Moreover,
subprime RMBS represented 60-75% of the RMBS collateral in these deals. The shift towards
subprime RMBS was motivated by the search for incremental yields around the triple-B level and the
increasing supply, which almost tripled between 2002 and 2004.
The main concern for the growing concentration of RMBS in CDO collateral pools is the growth of so-
called "affordability" products, such as 40-year mortgages, interest-only loans and certain adjustable-
rate mortgages (ARMs), but particularly option ARMs. These borrowers tend to have lower income,
and these new products are likely to experience more severe payment shocks when the principal
becomes due and/or the interest rate switches to variable.
3 Kabahar A. and R. Gambel, CDOs of CMBS May Feel Gust from Katrina, CDOpinions (6 September 2005).
4 Hurricane Katrina Could Affect $2.5 Billion In U.S. CMBS Collateral, S&P structured finance surveillance (9
September 2005).
5 According to the presentation at Moody's 5th Annual CDO Investor Briefing, New York, September 7, 2005.
6 Kiggundu-Bentham, M., et al., Is The Fortune for Structured Finance CDOs Tied To RMBS Performance For
Better Or Worse?, S&P CDO Spotlight (7 September 2005).
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Nomura Fixed Income Research
Given the higher risk associated with these affordability products, S&P identifies three core skills
necessary for the managers of SF CDOs: (1) close relationships with underwriters/originators, (2) the
infrastructure for monitoring/analyzing, and (3) the knowledge of the servicer market. However, the
strong RMBS market has so far led to collateral-related upgrades in 10 SF CDOs with high
concentrations (60%+) in RMBS.
II. Recent Pricing & Pipeline:
New Pipeline
Size (mm)
Collateral Man.
Assets
Lead
Sentinel CLO
$1,000.00
Lehman Bros. Asset Management
ABS
LB
Lafayette Square
$600.00
Blackstone Group
Loans
CITG
Ayresome CDO-Ⅰ
$400.00
General Re-New England Asset management Mezz ABS
LB
Taberna Preferred Funding III
$779.00
Taberna Capital Management
REIT TruPs ML
Symphony CLO-Ⅰ
$400.00 Symphony
Asset
Loans CITG
KLIO ⅢFunding
$4,000.00 Bear
Stearns ABS
CITG
FMC Real Estate CDO 2005-1
$467.00
Five Mile Capital
REIT CDO
DBS
Duane Street
$350.00
D/A Capital
Loans
MS
* denotes synthetic. Source: MCM, IFR, Bloomberg
III. CDS Spreads
5Y CDS Week Ago
Credit Rating
Mid
Week Ago
Name
5Y CDS Index
Change
(9/9)
(9/2)
(M/S/F)
(9/9)
(9/2)
Fannie Mae
14
15
Aaa/AAA/AAA
CDX.NA.IG 4
50.05
53.34
-3.29
Boeing 18
18
A3/A/A+
CDX.NA.IG 4 HVOL 111.98
119.27
-7.29
IBM 20
20
A1/A+/AA-
CDX.NA.HY
4
362.72
380.83
-18.11
Deere & Co
21
22
A3/A-/A
iTraxx
Europe
35.86
37.22
-1.36
GE Capital
23
23
Aaa/AAA/--
iTraxx Europe HVOL
65.77
69.89
-4.12
Alcoa 25
26
A2/A-/A
ITraxx Europe X-over 277.57
290.04
-12.47
AIG 27
27
Aa2/AA/AA
iTraxx CJ Japan
23.00
23.31
-0.31
Dow Chemical
28
30
A3/A-/A-
iTraxx Asia ex-Japan
46.25
47.94
-1.69
SBC Communications
33
33
A2/A/A+
iTraxx
Australia
28.63
29.08
-0.45
Walt Disney
34
34
Baa1/A-/BBB+
McDonalds 34
36
A2/A/A
Duke Energy
35
34 Baa1/BBB/BBB+
CIT Group
37
37
A2/A/A
AT&T 40
40
Ba1/BB+/BB+
Viacom 49
51
A3/BBB+/BBB+
Time Warner
54
56 Baa1/BBB+/BBB+
Computer Associates
69
67
Ba1/BBB-/BBB-
Altria Group
107
109 Baa2/BBB+/BBB
Albertsons 263
213
Baa2/BBB-/BBB
Ford Motor Credit
421
437 Baa3/BB+/BBB-
GMAC 467
474
Ba1/BB/BB+
Source: Markit and Bloomberg
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Nomura Fixed Income Research
IV. CDS Index Tranche Indicative Spreads & Base Correlation
iTraxx Europe Series 3
September 9
September 2
Weekly change
Overall index spread
35.8 bps
37.5 bps
- 1.8 bps
Spread
Correlation
Spread
Correlation
Spread
Correlation
0%-3% (upfront payment +
running spread = 500 bps)
26%
11.7%
26%
15.3%
+ 0.5%
- 3.6%
3%-6%
77 bps
23.3%
90 bps
28.0% - 13.1 bps
- 4.7%
6%-9%
26 bps
31.3%
28 bps
37.3%
- 1.7 bps
- 6.0%
9%-12%
14 bps
37.7%
16 bps
44.6%
- 1.9 bps
- 6.9%
12%-22%
8 bps
52.9%
10 bps
61.6%
- 1.6 bps
- 8.7%
CDX.NA.IG Series 4
September 9
September 2
Weekly change
Overall index spread
50.3 bps
53.5 bps
- 3.3 bps
Spread
Correlation
Spread
Correlation
Spread
Correlation
0%-3% (upfront payment +
running spread = 500 bps)
43%
7.3%
43%
10.5%
+ .2%
- 3.2%
3%-7%
115 bps
22.9% 140 bps
27.5% - 24.7 bps
- 4.6%
7%-10%
29 bps
31.1%
38 bps
36.5%
- 9.2 bps
- 5.4%
10%-15%
17 bps
41.1%
23 bps
47.3%
- 6.2 bps
- 6.1%
15%-30%
8 bps
61.7%
11 bps
68.9%
- 3.3 bps
- 7.2%
Source: Nomura
--- E N D ---
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Nomura Fixed Income Research
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