Merrill Lynch is structuring several innovative synthetic securitizations to tweak extra basis points out of a credit market in which the arbitrage opportunities have all but disappeared. Philippe Hatstadt, the firm's newly installed head of structured credit derivatives trading in New York, said investors are crying out for higher returns and the firm is looking at structural innovations and new asset pools to jack up yield.
One of the deals in development is comprised of a synthetic collateralized debt obligation that will reference a pool of credit-default swaps as well as options on default swaps, said Hatstadt. Merrill expects the extra leverage offered by the options will give it a return of at least 110 basis points on the assets, which is around 30bps higher than a plain-vanilla CDO--a level the credit markets have not seen for six months. These exact returns will depend on the volatility of asset spreads as well as whether the firm uses American or European-style options, he noted.
Spreads have tightened enormously over the last year and some investors are looking at buying credit protection to prop up their CDO portfolios or profit from any future widening, according to buy and sell-side credit professionals. Merrill is resecuritizing a CDO of CDOs to allow structured credit investors to short credit risk. In the deal, Merrill structures a synthetic CDO of CDOs, referenced to 10-20 unfunded mezzanine tranches, and then issues equity and mezzanine notes collateralized by the portfolio.
In addition, Merrill is planning to build on a series of synthetic CDOs it issued last year, dubbed MINT. The new deals will reference static pools as an alternative to the managed pools already available. As with the previous issues, the new structures will include features that reinvest a substantial part of the equity returns into the structure, which allows mezzanine investors greater participation.
