Lehman Brothers and Société Générale are structuring synthetic collateralized debt obligations based on reference portfolios of 1.5 billion ($1.28 billion) and 500 million, respectively, according to indicative term sheets obtained by LMW sister publication, Derivatives Week. SG's deal, called Grande Armée, is a five-year CDO referenced to 45 loans. The Lehman Brothers transaction, dubbed Sprint 2001-4, is a seven-year arbitrage deal structured on a portfolio of credit default swaps referenced to 100 corporates. Officials at Lehman and SG declined all comment.
The structure of the Lehman deal is unusual because credit default swap liquidity is in the five-, rather than seven-year contract, noted a credit derivatives professional in London. He speculated Lehman Brothers is taking a maturity mismatch--structuring a seven-year deal based on a five-year portfolio. This is risky because if spreads tighten in the sixth and seventh years of the transaction the bank will have to eat the costs. On the other hand if spreads widen it will make a profit, he reasoned.
Both transactions are split into four and investors can gain exposure via either credit-linked notes or credit default swaps. A significant difference between the two is the Lehman Brothers transaction does not allow substitution of assets in the portfolio, whereas the SG deal does. Static portfolios are usually aimed at sophisticated European investors who carry out extensive credit analysis and then want to keep the credits, whereas managed portfolios are more popular among U.S. investors who trust the manager to avoid fallen angels, the London-based credit professional said.
In SG's Sprint CDO the bank sells either $10 million or $20 million of protection on the corporates to a special purpose vehicle, which then issues credit default swaps. The corporates are roughly split into half between U.S. and European names. However the static portfolio of the Lehman Brothers transaction includes names such as Nortel, K Mart and Invensys, which some investors may be wary of, according to the London-based official. Lehman Brothers uses a recovery rate of 50% and therefore estimates 6.4 names have to default in order for the A2 tranche to be hit.
The Grande Armée portfolio originates from SG Global Credit Portfolio Management and AXA Investment Advisor. The portfolio has an average rating of A3/Baa1. The super senior tranche makes up 88% of the deal and will be sold via a credit default swap to an Organisation for Economic Co-operation and Development-based financial institution. The bank also plans to sell the two mezzanine tranches, Aa1 and Baa3, as credit default swaps, but is open to structuring these as credit-linked notes if there is investor demand, according to marketing material. AXA Investment Adviser plans to keep the 3% equity tranche.