After the Maiden Lane III MAX CDO sale, last week roughly $1.5 billion face value of super-senior CDO bonds or the entire remaining balance of WAVE 2007-1 and 2007-2 A1s were put out for bid, according to JPMorgan Securities analysts reported.
Like MAX, some dealers appear to have elected to collapse the transaction and have been taking bids on the cusips, they said.
Citing Intex data, analysts said that both WAVE 2007-1 and 2007-2 were downsized as a result of partial calls, which is a type of “in-kind redemption.” Analysts explained that this feature is when the owner of a vertical slice of the entire capital structure exchanges structured notes for a pro-rata share of the collateral.
They said that the winning WAVE bidder will likely use a strategy similar to the ML III trade. This is to line up bids from end buyers then to extract the assets at a profit net of deal costs, JPMorgan analysts said.
Deal documents show that there are two potential avenues to collapse the WAVE deals. The first alternative is an optional call where the collateral securities can be sold, although this needs the acquisition of the entire capital structure. An alternative approach would be an in-kind redemption, which has already been used to effect partial calls of both offerings in the last few months, according to analysts.
Under both circumstances, however, the buyer will need the consent of the swap counterparty, which would mean paying a termination fee. This has priority of payment over interest and principal to bondholders in the waterfall. Like MAX, the rate hedges for these deals is well out of the money for the CDO, the unwind costs are considerable, analysts said.
The range of accounts involved in the MAX unwind, such as the participation of real money in AMs and AJs, reinforces the notion that CMBS market liquidity and depth have improved considerably since the sell-off last fall.
If the two WAVE deals are collapsed aside from MAX, roughly $8 billion of market value ($9.5 billion face) will have changed hands in the last several weeks, which includes 18% of 2006/7 AJs, analysts stated.
This is a higher volume than what the market absorbed in the previous three months, which analysts consider impressive given the significantl worse liquidity conditions at the end of 2011.
Though the market’s ability to absorb this scale of risk transfer might mean that the depth of demand for cash CMBS has improved by a lot, analysts said that over the short-term, the secondary supply creates challenging technicals. Specifically, they think that a great amount of “dry powder” that has been allocated to the sector has now been deployed in these trades.
With many buyers already overweight in the CMBS sector, and some incremental demand now put to work, analysts think that CMBS spreads have limited near-term tightening potential.
Having close to $6 billion of market value back into the float means price risk for weaker quality AJs has clearly risen, they said. Between both the MAX and WAVE deals, 26% of the outstanding 2007 AJs will move from CDO structures back into the market float, mostly to a fast money bid, JPMorgan analysts reported.