CDOs Becoming ‘Unmanageable’ as Trading Costs Surge, Fitch Says

Managers of collateralized debt obligations are struggling to operate the funds because the cost of trading the underlying contracts has soared, according to a report by Fitch Ratings.

Some CDOs that package credit-default swaps are now “virtually unmanageable” because prices for the contracts have risen so high, Fitch said in the report today. Managers select contracts included in so-called synthetic CDOs, and seek to protect bondholders by trading out of companies that may fail.

Banks started closing down or scaling back units that bought and sold CDOs last year, Fitch said. That’s increased the spread between bid and offer prices for credit-default swaps that banks left in the market can demand.

“Those desks that remain in the correlation trading business have seen their allocated capital and risk appetite dramatically reduced, resulting in larger bid/ask spreads,” analysts Manuel Arrive and Lars Jebberg wrote in the report. The lack of market “liquidity” has become “a major hindrance” for managers of CDOs, they wrote.

The cost of credit-default swaps on the benchmark Markit iTraxx Europe index of investment-grade bonds has risen to almost 180 basis points from about 20 in 2007, according to data compiled by Bloomberg. That means it costs 180,000 euros ($239,000) a year to protect 10 million euros of debt from default for five years compared with 20,000 euros before the credit crisis.

The contracts used to speculate on corporate creditworthiness and a rise indicates a deterioration in credit quality. CDOs pool bonds, loans or credit-default swaps, channeling their income to investors in layers of differing risk

http://www.bloomberg.com/apps/news?pid=20601087&sid=a08cXmkLaiow&refer=home

I am so unhappy for the CDO desks...