Japanese CDO market shrinks in 2008, says Moody's

The collateralised debt obligation (CDO) market in Japan last year contracted by 12% to about ¥1 trillion ($10.2 billion) in terms of deals rated by Moody's Investors Service.

The agency rated nine balance sheet CDOs and 26 arbitrage deals last year, according to a report, 2008 Japanese CDO Market Review and 2009 Outlook, released on March 10.

The balance sheet deals totalled ¥729 billion, up 6.9% on 2007 volumes due to an increase in the size of portfolios referencing loans to small and medium sized entities (SMEs). The arbitrage deals accounted for ¥249 billion.

Moody's downgraded 34 tranches on arbitrage CDOs last year, most of which referenced global names that suffered credit events such as the US government sponsered entities Fannie Mae, Freddie Mac, Lehman Brothers, Washington Mutual, Tribune Company and the Icelandic banks - Kaupthing Bank, Glitnir Bank and Landsbanki Islands. The agency also changed 86 ratings assigned to repackaged deals.

Moody's believes risk management and funding benefits will drive issuance of balance sheet CDOs by Japanese financial institutions in 2009. But the agency reckons "only a limited number of SME CDOs will likely be structured considering the current situation of rising SME defaults".

Market sentiment towards arbitrage deals will remain poor, as it is elsewhere in the region. "Demand for the arbitrage CDO market may remain limited in 2009, as investors are likely to remain cautious," the agency said. However, the agency said simple credit-linked notes referencing one corporate name "will likely draw investors' attention".

Moody's added that no balance-sheet CDOs referencing Japanese corporates had suffered a credit event. But that situation may be set to change. "We need to keep in mind that a growing number of Japanese companies, facing a severe business environment due to the weak global economy and a strong yen, have been downgraded," Moody's said. Additionally, "some Japanese SME CDOs may also be downgraded".

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