Dresdner Kleinwort Wasserstein is structuring a USD3 billion synthetic collateralized swap obligation with a unique step-up coupon designed to assuage CDO investors who have been battered as a result of downgrades. In the deal, dubbed Petra, the second loss tranche is a single A rated credit-linked note with a coupon that jumps 50 basis points if it gets downgraded to BBB and 150bps if it goes to speculative grade, according to an investor who is familiar with the deal. The deal is likely to come to market in the next couple of months. Officials at DrKW declined comment.
Several investors have demurred at the prospect of buying BBB tranches of CDOs--the traditional second loss component--because they regard this as taking a sliver of the equity risk but not being adequately compensated for it. The fall in demand for these notes means these investors, rather than equity investors, drive the portfolio mix of most arbitrage deals, according to structurers in London. As a result firms have stopped putting BBB tranches in their deals and have increased the equity component to give the second loss tranche a single A rating. The unique feature of Petra is the second loss tranche is rated single A but it offers investors a potential yield pick up corresponding to a lower credit rating.
This step-up feature has been used before in corporate bonds and is quite common in bank loans, but has not been used in a synthetic CDO, according to rivals. It makes more sense to put the feature in a diversified deal, such as a CDO, rather than a corporate bond, because on a corporate deal a downgrade could put further downward pressure on the credit rating since the issuer would then be saddled with higher debt servicing costs.
The CDO is a five-year arbitrage deal referenced to a static pool of credit-default swaps. There is a 2.75% equity tranche and a 3.75% mezzanine tranche and the rest is sold as a super senior swap. The mezzanine tranche is split into single A, AA and AAA. The reference pool is also exceptionally diverse. No industry has a greater exposure than 5%, whereas the market standard is about 8%, and no single name accounts for more than 0.2% of the portfolio. U.S. credits are expected to make up 60% of the deal.
