Credit investors are turning away from structures with leveraged exposure to super senior tranches of collateralized debt obligations because of trepidation over embedded triggers. "It's a more complicated product than people first think," said David Littlewood, director at London-based asset manager Cairn Capital.
The triggers force the trade to unwind and leave investors with lost collateral and re-investment risk. They can be sparked by either spreads widening to a fixed level, accumulative annual portfolio default loss hitting a set percentage or the market value of credit-default swaps falling over time.
The deals, which aim to lure buyers with boosted returns but no dilution of the tranches' high credit rating, burst onto the market earlier this year and were given an added boost when correlation pricing problems pushed investors away from mezzanine and equity tranches (DW, 5/27). But although dealers say they have not eased off marketing the structures, investors are turning away now because they are closely reading the small print to figure out how sensitive the embedded triggers are.
One buy-side official said he has been pitched the deals but lost interest because the protection seller has the power to call the default risk percentage. "You are not as senior as you might think and can get killed quickly," he said. Another asset manager said he would still invest in leveraged super senior trades if the price was attractive.
Market officials said the first deals to hit the market were private, but most European derivative firms are now arranging public deals, including Citigroup and Deutsche Bank. "Every house has put out some spin on leveraged super senior," said Littlewood, who has not yet bought into the structure. Andrew Godson, v.p. in European structured credit at Citigroup in London, said his firm's leveraged super senior deal has been well received by clients who typically invest in AAA-rated mezzanine tranches and they are comfortable with the loss triggers on the deal set at levels consistent with AAA S&P and Moody's ratings.
Cian Chandler, associate director in the structured finance group at Standard & Poor's in London, said the agency has rated deals for a number of banks and will release an evaluation model for the structures in the next two weeks. Fitch Ratings has cleared two deals, but both Chandler and Richard Gambel, managing director of European structured credit at Fitch in London, declined to name the arrangers.