A large slice of the synthetic collateralized debt obligation market migrated to the single-tranche arena this year as a result of innovations in CDO structuring and spread tightening. In single-tranche offerings, CDO houses issue just one slice of a deal, typically a piece rated around the single A level, and then delta hedge the remainder of the portfolio, according to Robert Reoch, founder of Reoch Consulting.
The scale of the migration is illustrated by first half CDO volumes collated by Moody's Investors Service. The number of deals it rated doubled on the previous half year to 154, but the size of the rated tranches halved to EUR18 billion (USD19.7 billion). Richard Gambel, head of synthetic CDOs at Fitch Ratings in London, said, "Tightening spreads have encouraged growth in single-tranche CDOs at the expense of full-capital structure deals."
Tightening spreads and ratings volatility also contributed to an increase in single tranche deals referencing other CDOs or asset-backed securities. "There was a sea-change," said Stroma Finston, director and co-head of European CDOs atStandard & Poor's in London. In fact, the number of deals was so great that the rating agencies developed new models to rate them. For example, S&P now drills down to the single credit level of each of the component CDOs to rate the deal, said Finston.
The increase in volumes has led structurers to start talking about standardizing the documentation for single-tranche deals (DW, 9/28). Several houses, including JPMorgan, Merrill Lynch and Deutsche Bank, are working on the project. The main hurdle is deciding which valuation method to pick, but lawyers involved in the process predicted that standardized documentation would come into play early next year.