Static constant proportion debt obligations referencing a basket of names rated A to AAA, as opposed to investment-grade indices, are in firms' crosshairs. Sructurers working on the new deals see them as a way to avoid the index roll squeeze expected to afflict original CPDOs.
The buy-and-hold structures, however, will offer lower overall transaction costs for investors, according to firm officials. The structures would pay about 100 basis points and maintain an AAA rating.
UBS is said to be marketing a CPDO of this sort in the U.S. and Europe. It is understood to leverage protection sold on names in the financial sector that are rated, ranging from AAA to A. Other firms are looking at the same strategy applied to highly-rated sovereigns and utilities. These more heavily regulated industries enjoy more rating stability. Officials at UBS declined comment.
There are also costs associated with the mechanical CPDO including duration re-extension costs each time the index rolls and the costs of replacing names downgraded to high-yield with investment-grade names. These costs can be avoided by including names that are unlikely to be downgraded, according to an official working on such a deal.
A static CPDO referencing a basket of highly-rated names would also have a much shorter average cash-in time of three and a half years due to its higher rating. The original CPDOs had an average cash-in date of between five and eight years. A cash-in event occurs when the risky exposure within a portfolio is unwound. This happens if the portfolio's net asset value exceeds the net present value of all future liabilities.
