Tranche trading: The great credit correlation unwind - part 2?
Delphi’s bankruptcy shows that many of the imbalances remain in global structured credit.
In mid-October equity tranches in iTraxx and CDX rallied on the back of GMAC’s CDS tightening. The iTraxx five-year 0-3% tranche tightened slightly in October when it was announced that GMAC would get its own rating. But the general trend was for equity tranches to widen after Delphi, Northwest Airlines and Delta Air Lines filed for bankruptcy protection.
“Equity tranches have moved the most, although the GM news in mid-October prompted a bit of a snap-back,” says Lehman Brothers structured credit strategist Arun Singhal. “Mezzanine is too tight, so that’s where we’ll see the next repricing.”
Technicals are clearly important. Because of super-senior and mezzanine structured credit issuance, dealers are long. Their attempts to shift this risk off their books raises the price of equity. “Also, we have seen evidence of some unwinds of long correlation positions both from dealers and leveraged investors,” says Jeff Meli, Barclays Capital’s head of US structured credit and quantitative strategy. “That has forced implied correlations of equity tranches lower, and spreads have risen.”
The problem in May – one class of investors all holding the same risk – hasn’t gone away. “The imbalances that existed then exist now and have been pushing equity tranches wider,” says Singhal.