Demand for cash collateralized debt obligations referencing asset-basked securities is outpacing issuance of the underlying collateral, players say, and this is forcing dealers to structure cash deals with larger buckets of synthetic exposures. This is expected to widen the investor base for synthetic deals. "Traditional cash players may enter the synthetic space as they feel more comfortable with synthetics which now are included in some cash deals," said Michiko Whetten, a quantitative credit analyst with Nomura Securities in New York.
Credit-default swaps now comprise anywhere from 20%-40% of the structure, up from the 5%-10% levels commonly seen last year, Whetten said, noting the Merrill Lynch-backed Toro ABS CDO I, which has nearly 80% of its USD1 billion portfolio in residential mortgage-backed securities, features a 25% limit for synthetic exposures. "[The synthetic bucket] allows deals to ramp up more easily," Whetten explained. Independence VI, which, like Toro, was priced last month and has Merrill as the lead manager, is a similar deal also with a 25% limit for synthetic exposures. Chris Ricciardi, an official in Merrill's CDO group, referred calls to spokeswoman Terez Hanhan who did not return calls by press time.
Oliver Dunsche, head of credit derivatives structuring with Barclays Capital in New York, agreed deals with synthetic buckets result in a shorter ramp up period and give managers greater flexibility in handling the collateral. Market players also noted the inclusion of synthetics in cash deals shows managers and investors are becoming more comfortable with synthetic credit.
Last year, ratings agencies would not consider larger buckets of synthetics, Whetten added, noting they too have now grown comfortable with the synthetic market. Alla Zaydman, an analyst with Fitch Ratings in New York, said as long as the rating agency can see what is being referenced in the synthetic pool, and the documentation for the pool is up to rating agency standards, Fitch can feel comfortable that the synthetic bucket collateral will act as ordinary collateral.
