The popularity of leveraged super senior tranches this year figures to continue unabated as structurers look to add a range of bells and whistles to the investment products. Dealers searching to wring returns from tight credit spreads earlier this year hit upon leveraging super senior tranches (DW, 5/27), attracting investors with boosted returns but no dilution of the tranches' high credit rating. "They have been a '05 phenomenon," said Rob Pomphrett, head of the structured product syndicate at RBC Capital Markets in London.
The innovation initially caused headaches for the three major rating agencies, which had to develop models to analyze the nuances of the structures. In particular, they had to quantify new spread- or loss-based trade-unwinding triggers which protect the protection seller from absorbing losses exceeding the value of the purchased protection. (DW, 7/29). Perry Inglis, managing director and head of the European CDO group at Standard & Poor's in London, said these triggers have opened the structured credit market to mark-to-market plays. "They will no doubt come to fruition in 2006," he predicted.
By fall, dealers had souped up LSS trades by adding firstly third party managers to select underlying portfolios (DW 8/19) and then short buckets, a structure debuted by Bank of America in September (DW, 8/2). Most recently, Goldman Sachs launched a leveraged portfolio of credit-default swaps on asset-backed securities (DW, 11/4) and European dealers are now looking at leveraging mezzanine tranches to boost tight spreads in that sector (DW, 12/9).
The plethora of trades printed not only saw issuance eclipse CDO squareds, but had an adverse effect on spreads in the super senior tranche, which tightened by more than 50 basis points from July to September. To compensate, dealers turned to longer-dated maturities, namely seven- and 10-year, where higher yields present more attractive pricing options (DW, 11/11). Additionally, some firms have increased leverage factors from 10 times to 15 and 20 times.