Credit derivative houses have begun structuring managed leveraged super senior deals and pitching them in Europe. Up until now, the relatively new structures, which offer leveraged exposure to super senior tranches of CDOs, have not deployed third-party managers and tranches lower down the structure have not been this highly leveraged.
Merrill Lynch is marketing a deal and firms such as RBC Capital Markets, Deutsche Bank and Barclays Capital have also considered trades. Managers are being employed to measure present value throughout the life of trades and reduce the risk of hitting imbedded triggers. "They assess value and mitigate the mark-to-market risk of the leveraged super senior transactions," said Walter Gontarek, managing director and head of global credit products at RBC Capital Markets in London, who has not yet structured a deal.
An official close to the Merrill transaction said the firm is looking to capitalize on investor appetite for leveraged trades. "[Investors] like the product, but they like it better with a manager," he said. Another structuring official said Merrill will be meeting target investors whose guidelines restrict investment to managed deals only. If printed, IXIS Asset Management will be employed to manage the Merrill offering. Christian Silianoff, spokesman for IXIS in Paris, did not return calls by press time.
The deals operate like a standard third party managed synthetic CDO, with the manager substituting deteriorating credit-default swap entities to avoid meeting trade-unwinding triggers. Triggers are either loss based (when the accumulative annual portfolio default rate hits a set percentage) or spread-based (when spreads widen to a set level).
Some firms have held back because they feel there is not enough money in the trade to make a manager viable. Matteo Sotti, head of credit exotic trading at Deutsche Bank in London, said there was little idiosyncratic risk in the super senior tranche and a manager's role is restricted to reducing exposure to credit events. "The value contribution is limited to avoiding defaults; they cannot prevent against the market widening in spreads," he said. Barclays Capital's Heikki Monkkonen, director and head of European correlation trading, agreed, saying the seniority of the tranche discounted the need for a manager.
But European CDO mangers have expressed interest in administering the leveraged super senior deals. "It's very sensible because there is a lot of rating migration and mark-to-market risk," said one U.K. hedge fund manager.
