The cash CDO pricing puzzle
Tensions between front and back offices over how to price cash CDOs are preying on some industry data providers’ minds.
Be it via evaluated or contributed pricing services, cash CDOs are seen as the “big problem” when it comes to getting accurate price quotes in the securitization market. Synthetic CDO tranches can be priced on a correlation basis but cash CDOs are a far more tricky proposition. “If cash CDOs are actively managed and the collateral is constantly changing it is very difficult to accurately value them,” observed Ian Blance of FT Interactive Data at a recent European Securitisation Forum seminar on the topic. “If there is one asset out there that only has one price available it will be a cash CDO.”
One of the problems is that deals in the CDO market are far smaller than in the wider ABS market – you just don’t get €5 billion benchmark trades to price deals off. “There is an inherent liquidity issue within the CDO market,” Edward Cahill, head of CDOs in Europe at Barclays Capital tells Euromoney. “Deals are just not big enough.” And, because they are small, most cash CDOs will only have one lead manager making a price as opposed to larger ABS trades that will have two or three lead managers.
Cahill points out that, despite the illiquid nature of the market, cash CDO tranches are reasonably straightforward to price.