More on CDO's

The Bloomberg article referenced in the last post is worth fleshing out a little more.

As mentioned in the article sales of securities used for CDO's fell 80% this month from $42 billion in June to $9.1 billion. Amongst others Maxim Capital Management in New York and Paris-based Axa Investment Managers have delayed or scrapped planned CDO sales this month.


So who is going to be affected by the drop-off in CDO sales?

Prviate Equity

Kravis' Kohlberg Kravis Roberts & Co. and Blackstone Group LP, need to borrow at least $300 billion in coming months to finance acquisitions, according to Baring Asset Management in London.

That's a fair chunk of change to have to borrow as investor start to demand significantly higher yields to compensate for the risk of losses. That's not to say that some of these deals will fall over, they might well all go through as planned. However the private equity binge was built on the assumption of a never ending gravy train of cheap credit. That is now coming to a quick end.

Home Owners

CDOs also financed growth in lending to home owners with poor credit or high debt, known as subprime mortgages. About $50 billion of home loan debt rated BBB and BBB- went into CDOs in 2006, almost the same as the total sales of mortgage backed securities with identical ratings, Citigroup Inc. analysts estimated in a report in April.

We know now and can see the effect on home owners and potential home owners. Stricter lending practices and higher interest rates. These factors are showing up in home sales data.

Brokers

Merrill Lynch is the biggest underwriter of CDOs, selling $55 billion last year. Banks collected a total of $8.6 billion underwriting CDOs last year. If July is any indication the majority of these fees will evaporate. In addition firms such as Citibank are raising their loan loss provisions. Both a drop-off in fees and increases in loan losses (and remember we haven't hit the top of the mortgage reset cycle yet) are going to take a chunk out of earnings which I suspect will start to become ore apparent in the coming quarters.

If you read on in the article you will see that some deals are still going ahead and dealers are saying that this month is just a lull and consequently a good time to get back into the market:

We don't know when it will come back, but it should,'' said Dagmar Kent Kershaw, who helps manage 6.5 billion euros of CDOs at M&G. ``We believe now is a good time to get into the market, as some of these assets are cheaper than they have been for a while and offer excess value to the savvy investor.''

I wanted to quote that line because I'm quite certain I'll be able to come back sometime in the near future and have a good laugh at it.