Japanese CDOs hit record levels, but investors may receive raw deal

The issuance of Japanese collateralised debt obligations could hit a record ¥3 trillion ($25 billion) this year, but investors may not be receiving enough spread for the risks they face, according to a report this week by Moody’s Investors Service.

The credit rating agency said closure of Mizuho Corporate Bank's Cubic One synthetic collateralised loan obligation (CLO) “has proved that Japan’s CDO market has grown beyond expectations as investors digested such a large issue at one time". Mizuho closed the three-year ¥1.265 trillion synthetic CLO in late September.

Similar transactions are expected as other banks such as UFJ Bank and Sumitomo Mitsui Banking Corporation look at the possibility of issuing their own synthetic CLOs.

But report author and Moody’s senior analyst, Yusuke Seki, warned that investors may not be paid enough for the risks they are taking with regard to arbitrage synthetic CDOs. “Moody’s is strongly concerned that CDO investors to such transactions in Japan are not enjoying enough credit spread commensurate with credit risks,” Seki stated in the report.

“The lack of adequate spreads results from the fact that most of synthetic CDOs and first-to-default transactions in Japan are private transactions with a limited number of investors, and the information on such transactions is rarely disclosed,” she added.

The agency noted that, of the 21 CDOs worth ¥2.4 trillion issued so far this year, more than 80% were of a synthetic nature.