Back from the abyss
After a horrid 2008, the pendulum swung back fiercely for CDOs in 2009 – ex US
SF CDO – as a number of sub asset classes, led by CLO, have posted their best
price performance ever. At the core of this strong price recovery is the liquidity
infusion that has supported risky markets since late Q1 this year, leading to 1) a
slowdown in the pace of defaults and 2) important cross-product flows into
structured assets, on relative value considerations.
De-levering interrupted
Liquidity forbearance has pushed back the pressing need for de-levering in
CDO/CLO bonds, their underlying assets and their investors’ balance sheets. We
continue to believe that short of a very strong macro recovery, this de-levering
process may continue to loom over credit performance in the long run. In the
mean time, mezzanine CLO assets should continue to be supported by this shift
from front-ended to back-ended default risk.  
To have and have not
Throughout the rally, a clear pecking order has started to appear within the
various CDO sub-sectors – with the degrees of separation from liquidity sources
acting as the main differentiation factor. Access to non-bank capital as a funding
alternative to replace the securitization process has been a distinct advantage in
2009 and should continue to be so in 2010, as bank lending woes remain in
focus.
In 2010…
We look for a continuation of the increased tiering observed in recent months after
the initial broad-based boost to all assets. This differentiation should occur along
the (inter-related) lines of 1) access to liquidity and 2) price-distressed vs. credit-
distressed. Defaults should top out in 2010 for big caps, with mid-markets/SMEs
lagging. The relative value proposition in structured products remains (versus
plain credit and TALF assets), although the gap continues to narrow – opening a
window of opportunity for primary issuance in the CLO space. Further down the
road, we continue to look for signs that the deep structural issues of excess debtare addressed in more permanent fashion.