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Derivatives

Spread Tightening Cloud Falls On Rated Equity

Investment grade-rated equity tranches of collateralized debt obligations have not met expectations as tightening spreads in the fourth quarter made the deals unprofitable to issue.

Investment grade-rated equity tranches of collateralized debt obligations have not met expectations as tightening spreads in the fourth quarter made the deals unprofitable to issue. The tranches received ratings as high as A because they paid a lower but guaranteed coupon.

Much hype surrounded Lehman Brothers' and Prudential M&G's debut of rated equity over the summer (DW, 6/9) and nearly every bank and manager on the Street was looking to imitate it (DW, 8/25). A number of deals closed, including by Deutsche Bank and Cheyne Capital Management (DW, 10/23), Citigroup and Credaris (DW, 11/17) and Credit Suisse and Cairn Capital. But tightening spreads--which many market participants attributed to issuance of constant proportion debt obligations, the other new hot product--caused a number of deals to be postponed or restructured mid ramp.

Market participants said rated equity has earned a lasting place, but did not prove as exciting as many had expected. Jeff Meli, director and head of U.S. credit strategy at Barclays Capital in New York, said rated equity is more popular with European rather than U.S. investors, but added, "Finding equity investors is hard, even in rated form. The mezz format is still the most successful."

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