Like a cup of hot cocoa clasped in the hand, market talk is warming up to value found in synthetic multi-sector CBOs.
When compared to their cash counterparts, synthetic MS CBO investors stand to benefit from a spread pick-up. Market sources believe the pick-up in triple-As to be as much as 15 basis points; 20 basis points for double-As; and as much as 60 basis points in single-As.
According to Lang Gibson, Banc of America director of structured credit research, several other factors currently converging in investors’ favor include reduced ramp-up risk, increased diversification, flight-to-quality trade and avoidance of exposure to temporary write-downs in the collateral.
In BofA’s Dec. 6 Structured Credit Strategy Weekly, Gibson writes that multi-sector CDO issuance has occurred mostly in cash, primarily due to inconsistencies in the current rating system for synthetic structured notes. On the other hand, issuance of synthetic investment grade corporate CDO continues to grow at a strong clip, thanks to clear funding advantages.
Inconsistency on the part of the ratings agencies isn’t the only factor of course – difficulty in defining a credit event for back-ended defaults and the lack of a single-name CDS market for structured products, were also cited.
As a result, both groups have targeted different rating categories; cash MS CBOs target triple-B weighted average ratings (WARs) while pools with triple-A/double-A WARs have been the focus of synthetic MS CBOs. It is believed managers will now move toward synthetic CBOs, given the ability to focus on the top tier of capital structure, an opinion based largely on substantial mezzanine spread widening seen in October. Sources noted the spread widening indicates the market carries a perception of risk in mezzanine structured products.
Therefore managers can diversify to senior-rated notes, typically less costly to manage and monitor, via the synthetic structure.
