Single-tranche collateralized debt obligations referenced to high-yield credit derivatives are starting to gain traction because of a combination of increasing liquidity in the underlying swaps and investor demand for yield. Traditionally only investment-grade credit-default swaps have been liquid, but credit derivatives indices have brought liquidity further down the credit spectrum. Andrea Fabbri, co-head of European credit sales at TD Securities in London, said these deals are likely to increase in popularity over the coming year. He added that many CDO investors have large concentrations in investment-grade CDOs and are hunting for diversity.
Eric Oberg, head of North American credit derivatives sales at Goldman Sachs in New York, said as liquidity in the swaps underlying indices increases, firms are able to offer single tranche CDOs referenced to more types of debt, including high-yield.
The existence of a large true sale high-yield collateralized debt obligations market in the U.S. has helped investors to become comfortable with high yield as an asset class, noted Jeff Zavattero, co-head of structured credit derivatives at Bear Stearns in New York.
These deals have been slower to replace cash CDOs than their investment-grade equivalents because the deltas of the individual names move around more dramatically and it is more expensive to hedge, noted one credit structurer. Sivan Mahadevan, head of credit derivatives and structured credit research at Morgan Stanley in New York, said most high-yield credit risk in structured products is in collateralized loan obligations, rather than synthetic high-yield CDOs.
Zavattero noted brokers are starting to show interest in high-yield credit derivatives, which will help enhance liquidity in the asset class.
