Dealers are pitching structures with leveraged exposure to super senior tranches of CDOs to lure buyers with boosted returns, but no dilution of the tranches' high credit rating. One house, for example, is offering investors 10 times leveraged exposure to the super senior tranche in a deal which retains a AAA rating, but ratings analysts say most trades have a AA rating.
The deals have taken off in recent weeks as upheaval in the credit market has disjointed the relative value of CDO tranches and made the super senior tranche more attractive to investors, according to credit officials. Perry Inglis, managing director and head of the European CDO group at Standard & Poor's in London, said he has seen proposals from half-a-dozen banks and has already rated several deals. Dealers including Citigroup and Deutsche Bank have been actively marketing the structures. One structured credit sales official said, "I am sure we will see a lot more of these over the next few months." But he noted, "That's as long as the fundamentals don't go away."
Investors, however, say although the deals sound straightforward, the leverage means banks are putting margin calls into the deals to help them manage the products when spreads are volatile. Credit investors are comfortable taking exposure to default risk, but the possibility they might be asked to unwind the trade at certain spread levels means they are taking spread risk they don't want, explained one investor who has been pitched these trades but chose not to buy into them. "In principal it sounds like an attractive product," he noted, adding, "But we have to get over the hurdle of exposure to credit widening."
The spread risk also complicates the rating procedure, explained Inglis. This is because the trigger features and margin calls mean the deals are market-value linked and although ratings agencies are used to measuring default risk, they do not usually look into mark-to-market history of the credit. "It requires quite a lot of research and more bespoke modeling," he noted. The deals can take two-three months to rate, added another analyst.
