Managers of true sale collateralized loan obligations, including Credit Suisse Asset Management, are adopting synthetic exposures to indices as a means of generating yield and reducing negative carry as tight spreads and an active loan community pose challenges to sourcing loans for new deals. David Tesher, managing director at Standard & Poor's in New York, said the ratings agency saw the first such deal hit the market in December and several more are in the pipeline. Managers are also looking to purchase exposure to synthetic indices in case loan prepayment results in surplus cash, he added.
As yield-bearing loans became increasingly difficult to source there are concerns that managers could drift down the yield curve to fill the deal, said Tesher. To avoid this possibility, managers have began structuring credit-linked notes referencing synthetic high-yield indices, such as Credit Suisse First Boston's Select Aggregate Market Index "SAMI" (Secured) index. Tesher expects that other high-yield indices, such as TRAC-X or iBoxx, may also be used.
Nik Khakee, director at S&P in New York, added that the notes offer managers greater flexibility as they give managers time to be more selective when ramping up their portfolio. The strategy does, however, pose mark-to-market risks because when a manager buys more loans, they will need to sell some of their position in the credit linked notes and this may come with a trading loss, depending on the underlying index, he said.