Credit officials in Japan are expecting synthetic collateralized debt obligations with step-up subordination to take off in the coming months, following initial forays and growing client awareness. "This type of deal will be commonplace next year," said Ichinori Kitahara, chief analyst in the structured finance ratings group at Ratings and Investment Information in Tokyo. In the structure, the level of subordination increases each year until maturity, giving greater cushioning against default in later years. Kitahara explained, for instance, a CDO could begin with 2% level of subordination and increase the level by a percentage each year until maturity.
"Clients can forecast economic conditions for the next year, but after that it gets more difficult. This provides them with an increased comfort level," said an official at Daiwa Securities SMBC, explaining that while offering similar ranges of yield to traditional CDOs, the extra protection at the back end of the deal is a selling point. Credit structurers noted that continued expected economic growth in Japan should carry on for 2006 but for further time frames the picture is less clear. "From an economic cycle/fundamental point of view, this structure makes sense," said the official at Daiwa.
Officials continued that a few initial deals have recently been launched in Japan, but the concept should gain greater acceptance with further investor understanding and become more prevalent in the coming months. "This is new in Japan," noted a credit head at a bulge bracket house in Tokyo. The credit head said his firm is currently working on such a deal using step-up subordination but declined to further comment as it is still being finalized.
Credit houses also see the product as bringing a slightly new angle for deals on Japanese underlying. Growth has been limited this year as many investors have been turning their attention to overseas portfolios which offer more attractive yield as credit spreads in Japan remain much tighter than in other markets. However, the step-up feature could bring back more interest to the onshore market given the defensive nature of the deal in future and less certain years.
