State Street Global Advisors is set to close a first-of-a-kind collateralized debt obligation on Nov. 4, according to Securitization News, a CIN sister publication. The $400 million Diogenes CDO will employ a long/short strategy. Mark Adelson, head of structured finance research at Nomura Securities International, said to his knowledge no other structured product CDO has used that strategy.
Diogenes will be long the triple-B, mezzanine portions of home equity asset-backed securities while shorting corporate debt through credit default swaps. While State Street likes the spread the mezz paper offers--on average 130 basis points over LIBOR--the CDO manager is wary of its risk, explained Jim Hopkins, principal at State Street in Boston. "We'd be disinclined to be outright long in triple-B mezz debt given where we are in the economic cycle, how levered consumers are and the frothiness in some sectors of the housing market," he said. State Street manages about $3.4 billion in structured products CDOs.
The underlying collateral of the Diogenes CDO is composed entirely of structured products, with 70-80% devoted to bonds backed by residential mortgages and the balance divided among ABS CDOs, commercial mortgage-backed securities and ABS backed by student loans, credit cards and other collateral.
The firms State Street will buy credit protection on include home equity originators and mortgage insurers. Hopkins declined to provide examples, but commented the names were chosen for their high correlation between their securitized and unsecuritized debt.
The cash for the short positions will come out of the deal's cash waterfall. If State Street decides to take off its short positions, that money will go into a reserve account and be used as credit enhancement, Hopkins said. The highest triple-A tranche of the deal was priced Oct. 7 at 24bps over LIBOR. Deutsche Bank is the underwriter.
