Leveraging mezzanine tranches of collateralized debt obligations to boost tight spreads in the middle slice of the capital structure is the latest idea being toyed with by structured credit officials. Talk of the deals has gained momentum in the past few weeks, driven by investors familiar with leveraged super senior structures asking firms to examine a mezzanine counterpart. "All firms have been looking at it," said one official at a European house. He added a transaction should hit the market early next year and his desk is working on one.
The structures would likely lever AAA-rated portfolios to get AA-returns, said Rob Pomphrett, head of the structured product syndicate at RBC Capital Markets in London. "It's being considered because volatility and correlation has pushed value out of mezz tranches," he noted, adding his firm has not yet structured a deal. "Demand is moving from the wings to the center," agreed one credit official. "This is a natural evolution as value goes up and down the capital structure."
A number of players expressed concern at the higher levels of volatility in mezzanine tranches and said returns on leveraged portfolios would not justify the gap risk that would need to be carried by firms. "The further you go down the structure the more expensive gap risk becomes," said one analyst. Perry Inglis, managing director and head of the European CDO group at Standard & Poor's in London, said his group has not yet fielded inquiries for leveraged mezzanine, but expects it to develop. An official at Fitch Ratings said the agency has handled inquiries about the structures, but has yet to receive a deal to rate.
Leveraged super senior transactions, which offer investors boosted returns but no dilution of the tranche's high credit rating, took off earlier this year (DW, 5/27) when disjointed relative value made returns in the senior tranches of CDOs more attractive to investors. But the huge number of leveraged super senior deals issued by firms has squeezed value from the senior tranches, so that portfolios which were returning 150 basis points in May now return around 50 bps, traders said (DW, 10/7). Dealers declined to speculate if loss or spread triggers would be attached to leveraged mezzanine tranches.
