NEW YORK – Investors, emphasizing the separation between credit and structured finance markets, reiterated that the Ford Motor Credit Co. and General Motors Co. corporate credit downgrades are a non-issue in the cash CDO market. In fact, some portfolio managers are loading up on Ford and GM securities now – effectively increasing their exposure – in order to benefit from the wide spreads and low prices.
“The good news is, for cash flow CDOs, exposure to GM and Ford has been very, very low,” said Matt Natcharian, investment director at David L. Babson & Co. “What’s interesting is that exposures are increasing – a lot of managers are adding that risk to their portfolios – we are seeing exposure going up over the last month,” he said.
Investors, he said, are mostly purchasing at the short end of the curve. The move could reflect uncertainty about the companies’ future. “There is an underlying unease about the sector,” said Fred Horton, managing director at GSC Partners.
Denise Crowley, senior portfolio manager at Zais Group LLC, called the impact of GM’s downgrade on cashflow CDOs “de minimis.” The rating agencies tend to agree with that sentiment, reporting the preceding week that the corporate credit downgrades are unlikely to affect ABS tied to the names. Meanwhile, both Fitch Ratings and Standard & Poor’s issued reports last week denouncing significant impact on the synthetic CDO market.
“Only when the CDOs were stressed to the point that all autos referenced were downgraded did some CDO ratings come under pressure for downgrade,” Fitch wrote in a report released May 16. While widespread, Ford and GM concentrations within each portfolio were relatively small, and the corporate credit downgrades, amounting to one notch for Ford and two for GM, were “relatively modest,” according to S&P.
Of the 745 rated CDO tranches referencing Ford and GM, only 10 – or 1.3% – will be downgraded as a result, and in each instance, the downgrade will be only one notch, S&P wrote in its May 13 commentary.
“Unless we actually get some of these credits to default, these portfolios, be it synthetic or cash, won’t be impacted,” Crowley said, adding, “They may have a haircut, but not much else.”
So-called CDO and synthetic negative publicity in the press the preceding week had investors, who said the effect of the downgrades was much smaller than insinuated, riled up. “There were no major blow-ups as reported,” said Ralph Cioffi, senior managing director at Bear Stearns Asset Management.
All agreed that this was the first big test of the synthetic market, and that hedge funds involved in correlation trading did take a hit. But, all the instability has created new opportunities. Chris Testa of Drake Asset Management Co. said he’s starting to see a lot more curve deals as volatility in the CDX index picks up. Because of its increasing size and liquidity, that market is much quicker to react to spread meddling events such as headline risk, he said, allowing investors to take advantage of quick fluctuations in price and value.
There is still a lot of concern and volatility created by one of the large index houses on how the downgrades will be dealt with, said JJ McKoan, head of leveraged structured credit strategies at Alliance Capital Management.
“We certainly didn’t expect these names to widen as much as they did,” McKoan said, adding he is expecting significant volatility to continue until the market settles in at a fair price for synthetic exposure to the names. “It’s something that’s going to hang over this market for quite some time,” Drake Asset’s Testa said.
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