Issuance of synthetic notes employing a long/short strategy on credit are soaring on the back of Standard & Poor's introducing a model that recognizes the benefit of the short bucket in offsetting defaults. This means less subordination is needed to achieve the investment-grade rating, making it easier to attract investors who can buy into higher-rated paper.
Flow figures, as usual in this private market, are tough to pin down, but anecdotally appear to be swelling. "These have been done for some time, but have taken off now because they are rating generated," said one buyside official.
Ally Chow, managing director at Calyon in London, said her firm has issued more than USD300 million long/short combination notes on a private basis, some with an investment grade rating. The house is also eyeing the launch of a syndicated transaction. Several other bulge bracket houses are reportedly beefing up issuance, including BNP Paribas. Officials from the firm declined comment.
The structures can feature a long equity tranche of a portfolio comprising around 100 names and a short pool of ten or more of the riskier credits. "This is a case of buying protection through the short, so the risk is neutral," said one strategist. "It's a positive carry trade." In another version, the shorts can be naked, meaning they don't feature in the long bucket.
A structured finance analyst at S&P in London said there has been a pickup in inquiries for long/shorts which give credit to the naked shorts. The analyst also noted buzz around the play because synthetic structures are becoming increasingly arranged with, and managed by, long/short-friendly institutions such as hedge funds. Structures are already being rated under the new model which comes into effect officially at the end of the month.
