Structured finance, the complex method of corporate debt and cash-flow management that some critics depict as a route around accounting rules, continues to be a brisk business for Wall Street.
The ratings agency
Moody's Investors Service
says the market for collateralized debt obligations, one of the more popular structured finance vehicles, is running well ahead of last year's pace. By year's end, Moody's expects the dollar value of CDOs to rise 20%-25% above last year's tally of $57 billion.
CDOs are a security backed by a portfolio of junk bonds, loans, derivatives and other assets. Companies, in particular banks, issue CDOs in order to convert illiquid investments into cash, or move assets and liabilities off their balance sheets.
For investors, the attraction of a CDO is the promise of buying a security that offers a steady revenue stream that's drawn from a diverse group of assets. Hedge funds and financial services firms are some of the biggest buyers of CDOs.
Critics see nefarious motive behind the deals, citing their handiness in adding a penny or two to per-share earnings toward the end of a quarter.
Frank Partnoy, a University of San Diego law professor and a former derivatives trader, says one of the allures of CDOs is that Moody's and
Standard & Poor's
often are hired to rate them, making such deals easier for some investors to buy. But Partnoy, a frequent critic of structured finance, says regulators have not focused enough attention on CDOs and the implications of their rapid growth.
The second quarter was a particularly active period for CDO issuance. Moody's says it rated 48 U.S. deals with a dollar value of $17.9 billion, up 43% from last year's $12.5 billion. A little over a third of the deals were marketed by
Credit Suisse First Boston
"Based on first-half 2004 issuance activity and the pipeline of new deals, we again see a need to revise upward our expectation for annual volume," says Jeremy Gluck, Moody's managing director. "At this point, growth for all of 2004 in range of 20-25% seems quite possible."
One of those deals in the pipeline includes the first-ever municipal-sponsored CDO. Moody's didn't identify the city planning on issuing a CDO.
The surge in CDO activity is not surprising. Last week both Moody's and
The McGraw Hill
, the parent company of S&P, reported higher second-quarter earnings and revenue, in large part due to their ratings work on structured-finance transactions.
But it's not just CDOs that are booming. Thomson Financial reports that the dollar value of all structured finance deals in the U.S., including mortgage-backed securities, is up 41% over the same time last year to $444 billion. The number of deals is up 35% to 878.