Collateralized Debt Obligations Market

Celent estimates that the CDO market will reach close to US$2 trillion by the end of 2006.

Due to impressive growth and innovation the collateralized debt obligations (CDO) market is drawing a lot of attention from players outside the derivatives industry. In a new report, " ," Celent demystifies these complex instruments and outlines the main benefits and uses of various CDO instruments. The report includes statistics on the size of the CDO market with a breakdown by geography and instrument, an analysis of CDOs impact on the financial services industry, and the IT challenges they have generated.

A CDO is typically a structured transaction in which a special purpose vehicle is established to sell credit protection on a range of underlying assets. Despite numerous credit events and difficult market conditions, the CDO market has continued to grow thanks to innovation. Since 1998, the CDO market has experienced an average annual growth rate of 150%. Celent estimates that the overall CDO market represents over US$1.5 trillion and will grow close to US$2 trillion by the end of 2006.

"The CDO market has become one of the most profitable markets for investment banks," given diminished IPO and M&A activity, says Axel Pierron, analyst and author of the report. "The growth of this market is not going to slow down dramatically, despite various hiccups," he adds.

The emergence of synthetic deals has clearly boosted the CDO market. The market is dominated by synthetic deals, and today 75% of CDOs issued are synthetic CDOs. This marks a clear evolution in the CDO market. In fact, the two most recent products, single tranche CDOs and ABS-backed CDOs, now account for, respectively, 66% and 25% of the synthetic CDO market. The market is moving toward "on demand" credit risk, where an investor can specify a products risk/return and the bank originates the "raw material" (bonds, ABS, etc.) and then distorts the risk/return ratio of its portfolio and delivers a new product to its client.

The development of the synthetic CDO market on the back of the CDS market is having a tremendous impact on the credit market, reorganizing the credit value chain. The development of the credit derivatives market and especially CDOs has had a tremendous impact in the positioning of banks in the risk management value chain," says Pierron. In the medium term, regional and smaller banks will concentrate on sourcing risk (especially via loans), while brokerage houses and investment banks will focus on deal structuring. The distribution will be shared between various players, from large banks to insurance companies, he adds.

The 42-page report contains 13 figures and 2 tables.

All Members of Celent's Institutional Securities & Investments research service can download the report electronically by clicking on the icon to the left. Non-members should contact info@celent.com for more information.