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By Jennifer Yousfi
With 80% of losses from the subprime crisis already reported according to a Fitch Ratings Inc. report released today (Wednesday), the collateralized debt obligation (CDO) market that many had written off for dead could be showing new signs of life.
Many have laid the blame for the current credit crunch squarely at the feet of poorly managed CDOs funded by mortgage-backed securities (MBS). When the true risk of such assets became apparent as the U.S. housing market crumbled, the CDOs quickly lost value.
As a result, the banks that sponsored the CDOs – which were often held by an independent special purpose vehicle – were forced to take over $323 billion in write-downs so far and shed an estimated 65,000 jobs in the financial industry.
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Fitch estimates that the subprime losses to date are evenly split between Europe and the United States, with $77 billion of losses for each, Reuters reported. Asia has seen an additional $10 billion in losses. And the bulk of those losses stemmed from MBS-backed CDOs.
But a new round of recent deals show that a few Contrarians are dipping a toe back into the CDO market.
Babson Capital Management LLC bought a $680 million CDO from Hartford Financial Services Group Inc. (HIG) this month. Meanwhile, Deutsche Asset Management (DB) replaced London-based Brevan Howard Asset Management LLP on a CDO in April, Bloomberg News reported.
"We absolutely believe the market will come back," Matthew Natcharian, the managing director for structured products at Springfield, Massachusetts-based Babson, a unit of MassMutual Financial Group, told Bloomberg. "We're actively looking for opportunities."
But Money Morning Contributing Editor Martin Hutchinson disagrees.
"I think CDOs will disappear," he said in a recent Money Morning analysis of CDOs. "If banks have to lend to [special purpose vehicles] in difficult markets, there is no justification in taking the [CDO] assets off the bank's balance sheet."
"And it no longer makes sense for a short-term investor to buy commercial paper from an SPV now that the true risk of such an investment has been exposed," Hutchinson added.
"With the two main rationales for CDOs removed, it seems unlikely they will survive, except in small niches of the market where special circumstances make them desirable," he said. "CDOs were always an unsound idea, and now they have contributed to the current financial crisis by forcing banks to bail them out, tying up money that the banks need for other purposes."
With banks eager to get those assets off their balance sheets, private equity firms with the sufficient capital are in demand as buyers. But many of the smaller firms that eagerly jumped into the market and don't have a comfortable capital cushion won't be able to sustain the current downturn, making it even harder to pull off new deals.
"If a manager wants to do new CDO deals, they are going to have to commit a substantial amount of their own capital," Brian James, a partner at Link Global Solutions, a New York-based structured finance consulting and recruiting firm told Bloomberg. But he added, "Certainly the market isn't dead."
News and Related Story Links:
CDOs Flicker to Life With Babson, Deutsche Takeovers