Structured Credit debate participants
AC, Euromoney Hubert, could you start us off with an overview of the market?
HLL, SG CIB The market is much more active in 2006 than it was last year. On the investor side, there is more volume with hedge funds and more activity with middle market investors and the private banking sector. And we’ve seen interesting developments in specific geographical areas. For example, the middle market in Australia has expanded dramatically, as well as being a strong retail market. And in the US we now have investors interested in synthetic – derivative – business, who were not ready for synthetic CDOs a year ago.
On the product side, there are new forms of leverage. A lot of leveraged senior was done in 2005, and in 2006 we have seen the development of zero coupon equity pieces. On the CPPI front, we’re also developing leverage based on value at risk (VAR). Lastly, in terms of asset class, we’ve seen more and more synthetic CDOs of ABS.
AB, Deutsche Just on the subject of leveraged super-senior – there is not much market at the moment as spreads have tightened so much. Additionally there is uncertainty over correlations at very high attachment points in bespoke deals, especially when the average spread is much wider than the index. People are comfortable with risk, but only up to a point.
JL, Solent When the correlation market crashed, the super-senior got cheaper, because there are not normally many natural players in it – just a few monolines and a few banks. So a few banks, Citi and Deutsche and a couple of others, packaged super senior together and leveraged it, between seven and ten times, creating a triple-A asset with very low default risk and a reasonable return. Some trades had spread triggers in and some didn’t. That trade was incredibly rich in July last year. By about October it had been all but exhausted. Investors had to act quickly to get in and that has become a characteristic of the market as a whole.
DP, Cheyne Capital It will be interesting to see if that market will return as spreads widen. I suspect there will be heightened focus on market-to-market triggers and margin calls on such positions with widening spread momentum rather than tightening. I do worry about the sort of leverage and mark-to-market triggers that have been employed on huge notional positions in vehicles with relatively poor access to liquidity.
JC, Fitch Well, yes, we’ve seen leveraged super-senior on corporates dry up to some extent. But what about on ABS?
AB, Deutsche It’s the same story. The market has tightened so much that it’s difficult to create and repackage anything. That said, even when the underlying spread is one basis point (bp), people are still happy to get five bps through leverage, providing they are not bearish on the market. Now people want returns of, say, 100 bps on a leveraged basis, and the market’s only offering 55, and most of them wait for a better opportunity when the spread widens. If the market continues to be very tight, people will re-strike their entry levels; otherwise they’ll wait for spreads to be 10 to 15 bps wider in general, and then they’ll go back to super-senior trades.
DL, Cairn There are certainly lots of investors waiting for the ability to print them. Investors did very well out of them in 2005 but we are worried by the negative gamma in the market that can arise because investors all tend to invest at the same time with similar portfolios. These products have spread or loss triggers and when investors start to lose money they all lose money together. We worry that these transactions can become unstable from a ratings perspective and from a de-leveraging perspective. Leveraged super-senior has its own specific risks and is a complex product for banks to manage. It is not the simple, risk-free product it is often marketed as. At Cairn, we did a managed leveraged super-senior product, taking the view that, with the negative gamma in the market, having a manager would make a real difference in preventing de-leverage. When the markets are stable it is also a nice environment to manage credit within to generate alpha for our investors.
AB, Deutsche It’s ironic to see how good the loss trigger trades have been for clients when we’ve seen that some dealers mispriced this option and executed at levels that were comparable to the spread trigger. This mispricing cleaned the market of some small players that were getting ahead of themselves.
JL, Solent Clearly the whole growth of synthetics in ABS has been another thing, although it’s been much more based in the US than Europe. That’s grown with a focus on the cash CDO market.
LF, Calyon Talking of other new trends, synthetics are going global. Before, just a few institutional investors across continental Europe plus Asia ex-Japan were interested, and that was it. Now, as Hubert says, the Australasia region can absorb very large ticket deals and A$300 million is the benchmark. Another new development in 2006 is the sale of managed synthetics into the US.
DL, Cairn The other trend is that, with investors now willing and able to participate in each level of the capital structure – in equity, mezzanine (mezz) and super senior – when an arbitrage appears in the synthetic market it doesn’t persist very long. As a consequence, banks are doing smaller and quicker deals. Gone are the days of big, global deals like Aria. Right now the market wouldn’t support a deal like that, but even if the arbitrage were there, by the time the deal had been structured and marketed, there would be a very real risk that the arbitrage would be gone.