Société Générale is structuring what is thought to be the first synthetic collateralized debt obligation referenced to high-yield corporates. The deal references a pool of 70 North American corporates rated B plus to BBB plus. Synthetic high-yield deals have not been done before because the credit derivatives universe is predominately investment grade and there is little liquidity in the high-yield sector, according to an investor. An official at SG, however, said it can use correlated products such as bonds and equities if liquidity in a name completely dries up.
Tight spreads in the credit markets have caused several firms to shelve deals and others to put investment-grade names that are trading wide in relation to their rating in the portfolio to boost the spreads. By moving the whole reference portfolio down the credit curve SG is able to eliminate barbells and increase subordination, according to the official.
The reference portfolio is selected using Moody's KMV, which makes for a more conservative pool than using regular credit ratings, as it includes stock prices and volatility, according to the official. The AAA tranche can sustain 17 defaults before the yield is reduced.
There are four classes of mezzanine notes rated BBB to AAA, each of which makes up 10% of the deal, according to an indicative term sheet obtained by DW. The CDO has three credit events, bankruptcy, failure to pay and restructuring.
