Cash flow collateralized debt obligations are starting to fill up on credit-default swaps, as a developing market for asset-backed protection is making these securities more attractive for inclusion in structured credit vehicles. Competition for bonds is causing managers who had previously maintained a synthetic allowance but had not fulfilled it to sell protection. By taking exposure in a synthetic form, managers can ramp up and close deals quicker while still getting the precise exposure they want--without having to fight for skimpy allocations in the increasingly competitive primary market. Typical ceilings on synthetics are around 10% for most cash flow deals, according to rating agency analysts. It could not be determined whether any such deals have closed and rating agency officials declined to discuss specific deals in the ramp-up process.
"You're seeing more of those buckets actually being used. Before, they had the ability to buy synthetics, but now they are actually buying them," said Mia Koo, director at Fitch Ratings.
Of course, this move into uncharted waters is not risk-free. Although dealers have generally settled into a degree of understanding on what triggers a default in asset-backed synthetics, the International Swaps and Derivatives Association has not yet come out with standardized documentation. Furthermore, the nascent market has yet to experience its first stress test. "The synthetic exposures may or may not add risk; there will be some growing pains, I am sure," predicted another rating agency analyst.
While the trend has been most evident in high-grade ABS deals, rating agency officials say it is running the gamut. "Sometimes you just can't find the bonds. It's used around the edges to get collateral that isn't available," noted Richard Gugliada, managing director and practice leader of the CDO group at Standard & Poor's.
