Fully-rated credit constant proportion portfolio insurance is set to take off in Europe following its debut by ABN AMRO. Dealers are scuttling to ramp up the structure which attaches a rating to the coupons of the notes, the riskiest component, rather than just the principal invested. The notes typically represent a portfolio of short credit-default swaps, or a credit index tranche. The innovation is tipped to throw open the market to a universe of investors who until now have shunned credit CPPI because of the uncertainty of returns. Officials at ABN AMRO did not answer calls or emails by press time.
"A lot of dealers are showing interest in this type of transaction," said Perry Inglis, head of the European CDO group at Standard & Poor's in London. He estimated at least three dealers will launch credit CPPI portfolios with rated coupons by the fall. Ally Chow, head of structured credit management and syndicate at Calyon in London, said her group is working on a transaction which will launch shortly. "Traditional bank buyers need a rated coupon and this will help expand the investor base," she noted. Fitch Ratings and Moody's Investors Service have also fielded inquiries, said internal officials.
Some structurers, however, have questioned the economics of the structure, noting a chunk of the upside must be paid away to guarantee coupon payments required by the rating agencies. "We would love to be able to do it, but don't want to strip out the attractive return profile of CPPI," said one senior structurer at a U.S. firm in London. Another estimated that on an underlying of synthetic asset-backed securities, the rating and guarantee cost could cut typical returns of 90 basis points over LIBOR on principal-only rated CPPI by more than half. "Investors should balance the need for coupon and the potential impact on the overall performance of the structure," said Calyon's Chow.
ABN brought the first private transaction to the market last month and it is road showing a second, public transaction. The coupon rating is based on where spread triggers--which move invested assets between the so-called risky and safe buckets--are set. The first assumes spreads will not widen to a certain high level which, if triggered, changes the mix of invested assets and negatively impacts the transaction. The second assumes that spreads will change over time but be sufficient to hit a target return level that once achieved will positively change the invested asset mix. An official familiar with both methods said deals in the pipeline predominately feature the second method.
