Crédit Agricole Indosuez is structuring what is thought to be the first synthetic collateralized debt obligation referenced to convertible bonds. The firm is structuring the CDO, which could be anywhere between EUR300 million-EUR2 billion (USD321 million-2.14 billion), to lay off credit risk originated from its convertible bond stripping desk, according to Zouhair Bechchar, head of CB stripping in London.
Convertible bond arbitrage funds and stripping desks buy converts and hedge the equity and interest-rate risk. They are then left with the credit risk, which they hedge by selling asset swaps, issuing medium-term notes or buying credit protection in the default swaps market if it is available. Securitization would allow banks to offset large chunks of risk more efficiently, explained Bechchar. "This is a smart way of getting rid of the risk," said a rival credit structuring head in London. CAI executes around EUR3 billion of convertible bond trades a year, according to Bechchar, who added that it would aim to enter two or three of these deals before year end if investors like them.
Loïc Fery, global head of credit derivatives and structures in London, thinks the deal will appeal to CDO investors on two fronts. First, it offers diversification and second, convertible bonds pay a premium over vanilla bonds or default swaps because they have a callable feature. The embedded call will boost the spread investors receive. In addition, it will attract convertible bond investors that want leveraged exposure.
The CDO is likely to be around EUR300-600 million if it is purely referenced to convertibles, but could be as large as EUR1-2 billion if the firm diversifies the reference pool with other corporate debt, according to Fery. A rival banker said CAI may choose to diversify the pool as only a small section of the corporate world, namely growth companies, issues convertible bonds.
CDOs referenced to converts are likely to allow substitution or have an amortizing structuring, according to Bechchar. This is because the convertible bonds can be called.
