Single-tranche synthetics drive CDO volumes

Collateral debt obligation issuance was up 24% in the first six months of 2003 despite the credit derivatives market’s unusually tight spreads due to a flood of bespoke single-tranche synthetics, according to CDO analysts at Lehman Brothers.

In the firm’s CDO Monthly Update for July, Lehman CDO analyst Sunita Ganapati writes: “Growth was driven by the explosion of synthetic single-tranche CDOs from Europe, a consequence of dedicated correlation trading capital from the Street.”

“Close to $62 billion of funded par priced in the (arbitrage and balance sheet) CDO market globally through 265 transactions, more than half of which were European synthetic arbitrage transactions, an estimated 100 of which were single-tranche CDOs,” Lehman reports.

However, Lehman noted that the growth figure may be overstated because there has recently been more public disclosure of deals, whereas in 2002 most deals were private and Lehman’s figures for that year may be understated.

Lehman also reported that synthetic structures dominated in the first half, accounting for 60% of all CDO issuance, up from 46% in 2002. Aside from bespoke single-tranche deals, Lehman says: “the newest trend in the synthetic CDO market has been the burgeoning activity in structured finance synthetic CDOs.” Twenty-four of these closed in the first half, including some synthetic CDOs of CDOs, compared with 11 in all of 2002 and three in 2001, Lehman says.

Secondary CDO trading was another major factor in the market in the first half, Lehman reports. “Spreads rallied significantly during the first half of 2003 in response to the spread tightening in underlying collateral markets. The 289 [basis point] rally in the Lehman Brothers HY Index and the 80 bp tightening in leveraged loans pushed CDO NAVs higher, leading to better CDO valuations.”

Lehman says the secondary market is still active: “Heading into 3Q, we are still seeing a tremendous demand for secondary paper, which we believe will continue to put positive pressure on spreads…”