A rare equilibrium between the number of credit correlation buyers and sellers has given rise to an unusual situation in the synthetic market: an evenly-weighted capital structure. That balance could translate to high collateralized debt obligation flows during the typically quiet summer months.
Traders say long and short positions across all tranches are being sought equally because CDO spreads have remained stable during the recent period of credit weakness. In addition, innovations in CDO equity (DW, 6/9) and continued demand for senior tranches in leveraged format (see story, page 4) are perking up flow in the top and bottom tranches.
Also unusual, credit officials say, is the juice found in the mezzanine tranches. Typically, wider index spreads mean high bespoke mezzanine CDO issuance which pushes value to the ends of the capital structure. Strong demand for equity and senior risk, however, has pushed value back into mezz, despite recent widening in both iTraxx and CDX index suites. Strategists say wider index spreads, increased bespoke CDO activity and wider mezzanine CDO risk premiums are a first for the market. One official said he expects a number of jumbo mezz transactions to hit the market in the coming week and that BBB tranches are returning 200-plus basis points.
Andrew Jackson, credit risk manager at asset manager Cairn Capital in London, agreed the emergence of leveraged super senior, zero-coupon and rated equity alongside continued demand for traditional mezzanine synthetic CDOs has led to "a far more balanced capital structure than we have seen in the past." One head salesman at a European firm added he is seeing even-handed appetite for tranches across the capital structure, mostly at seven- and 10-year tenors. "Usually the market conditions mean we see higher preference for one," he noted.
Market makers are unsure how long balance will remain or what will be the next correlation mover. Most, however, agreed the structured bid, created through credit tranche issuing and hedging, will remain a key technical factor during 2006 and that CDO issuance should remain high during the summer on the back of volatility.