Derivative Fitch: Convergence of Cash & Synthetics Key for CDOs in 2007.

NEW YORK & LONDON -- The convergence of cash flow and synthetic CDO technologies was a key theme in what has been another strong year for the sector in terms of innovation and issuance, a trend that will continue in 2007, according to Derivative Fitch in its Global Structured Finance Outlook report.

"2007 holds much promise for the global CDO and credit derivatives arena as novel methods of packaging credit and market risks and new analytical models emerge. The ability for investors to evaluate the market risk of their credit derivative portfolios will be increasingly important," said John Schiavetta, Group Managing Director, Derivative Fitch.

As the global market matures, 2006 has also been notable for a cross-pollination of ideas between continents. For example, some U.S. collateralized loan obligation managers (CLOs) are aiming to take a piece of the action in the aggressively growing European leveraged loan market. Separately, the appetite for commercial real estate (CRE) CDOs has been spreading across the Atlantic as European issuers and investors aim to replicate the success of this sector in the U.S.

In the U.S., CDO issuance is up 36% through the first nine months of 2006 to reach approximately US$281 billion (compared to US$207 billion for all of 2005), according to Kevin Kendra, Senior Director, Derivative Fitch. In Europe CDO issuance reached EUR80bn (357 deals) by the end of October and is well on course to eclipse 2005's total of EUR101bn.

"The appetite for high yield loans remains unabated as we head into 2007 and corporate cash flow CDOs will continue to see increased issuance," said Director Jeffery Cromartie. "Synthetic and market value CDOs will also gain more traction as issuers and investors grow at ease with the use of credit default swaps and advanced investment applications."

Investment grade corporate CDOs, in contrast, were adversely affected by negative credit migration in the U.S. automotive sector as well as some credit deterioration in the broader corporate markets. The impact of increased leverage buyout (LBO) activity is another source of concern.

"LBO transactions often result in significant changes in corporate capital structures as well as increased risk associated with the entity's debt, and thus warrant closer analysis by Fitch to gauge their effect on CDOs next year," said Cromartie.

Derivative Fitch's report goes on to outline the 2007 rating and asset performance outlooks for all of the sub-sectors of the global CDO and credit derivatives market. Performance for both global leveraged loan CLOs and middle market CLOS is expected to remain stable, while CRE CDOs and TruPS CDOs will remain strong in 2007, both from a collateral and ratings perspective. The outlook for SF CDOs is mixed as early vintage diversified transactions' performance continues to lag. Recent CDOs backed by mezzanine residential mortgages are expected to show some deterioration, while high grade RMBS CDOs remain stable.

Derivative Fitch's 'Global Structured Finance: 2007 Outlook and 2006 Review' includes asset performance and rating volatility forecasts for the global ABS, CMBS, RMBS and CDO sectors in 2007. The report also evaluates the impact of broader macroeconomic trends on the global structured finance markets and gives an overview of asset performance and credit migration trends over the past year. In addition, a more detailed '2007 Global CDO & Credit Derivatives Outlook' will be released shortly. The reports are available on the Derivative Fitch web site at www.derivativefitch.com.

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