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Derivatives

Novel Low Quality ABS Tranche Deal Emerges

Credit Suisse is in the market with its first synthetic collateralized debt obligation referencing the lowest portions of both the off-the-run and on-the-run ABX asset-backed securities index.

Credit Suisse is in the market with its first synthetic collateralized debt obligation referencing the lowest portions of both the off-the-run and on-the-run ABX asset-backed securities index. The CDO contains a USD85 million leveraged tranche, tied to a bundle of the BBB and BBB minus stacks of the ABX. The total notional is USD600 million.

The coupon on the deal, from the firm's Magnolia series, could not be determined and calls to officials at Credit Suisse were not returned.

Only a handful of firms have large enough correlation books and adequate models in the U.S. to isolate sections of the ABX. Dealers said Goldman Sachs, Morgan Stanley, Deutsche Bank and, more recently, Lehman Brothers have been offering single tranches in varying sizes. In addition to lower-rated referenced tranches, CDO players have generally been more interested in structuring in ABX exposure (see story, page 2).

One issue holding firms back is that their correlation desks are set up to support corporate credit trading rather than ABS, leaving their traders unequipped to cater to ABS correlation requests.

Another and more serious issue is that dealers and clients alike do not have a standard way of valuing implied correlation in ABS--new ideas about spread trigger levels appear to be conjured up every week, said one correlation trader. "You have to really believe in your model, to do this amount of delta hedging," said one ABS strategist.

"They are doing this to take advantage of the spread arbitrage that exists right now, by selling that slice levered and going long the ABX on the other side," said a rival at another firm that has structured ABX deals.

Other firms such as Deutsche Bank and Goldman have also placed the entire capital structure of their latest ABX-linked deals by layering some tranches with single-name CDS in addition to the index tranche. Goldman was in the market two weeks ago with a USD2 billion notional deal that is 60% linked to the ABX and 40% linked to single names.

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