Introduction to Securitization

GROWTH OF THE CDO MARKET

The CDO market originated in the late 1980s. However, during the early years, the total issuance hardly ever exceeded a few billion dollars. The real impetus came around 1996 when the risk-return profile of the high-yield debt market and the pricing of a triple-A rated floater created excellent arbitrage conditions. In 1998, the collapse of Long-Term Capital Management created a premium for liquidity in the market. Around the same time, rating agencies became more comfortable with rating of CDOs including those for arbitrage purposes.

The growth in the market was phenomenal from 1998 to 2007. According to data from the website of Asset-Backed Alert (www. abalert.com), worldwide CDO issuance was $65 billion in 2000 and by 2006 it increased to $431 billion. In 2007, issuance was $412 billion, a decline from the prior year due to the difficulties in the subprime mortgage market. In 2008, those difficulties carried over and issuance is expected to decline dramatically.

The composition of the CDO market in terms of cash flow, synthetic, and market value CDOs as of the third quarter of 2007 was:

 

Cash flow and hybrid: $315 billion (76%) Synthetic funded: $38 billion (9%) Market value: $59 billion (15%)

 

It should be noted that the issuance size of synthetic CDOs does not correctly reflect the level of activity since the funding raised in synthetic CDOs is only a small proportion of the pool size.

The composition of the market in terms of purpose, that ...