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Deutsche Bank, AXA Structure Jazzed-Up CDO

Deutsche Bank is arranging a EUR1 billion (USD8.98 billion) managed hybrid collateralized debt obligation, dubbed Jazz, which AXA Investment Managers will manage. Rival bankers said this is an innovative transaction and expect it to be one of the first deals to hit the market in which the manager actively runs a portfolio of default swaps. It could not be determined why the CDO is named 'Jazz', but one banker suggested it may be because Deutsche Bank hopes the deal will be music to investors' ears. Officials at Deutsche Bank and AXA declined to comment.

AXA will be free to use most fixed-income instruments, such as credit-default swaps, asset-backed securities and bonds, to gain exposure to investment-grade credits according to an indicative term sheet obtained by DW. It will also be able to jump between the instruments to obtain the best spread. In a static CDO the equity tranche can be decimated with only two or three defaults, according to a London-based structurer. In a managed portfolio the losses can be stemmed. For example, if AXA had sold protection on Railtrack at 100 basis points, in a static CDO portfolio the investor would have taken the full hit when the credit defaulted. Conversely, in a managed portfolio losses can be limited by reversing the position, in this case buying protection on the reference credit. This would limit losses to the spread between the price at which protection was bought and sold.

Officials familiar with the deal said it is being structured now because of the large risk premiums offered in the credit derivatives market. But managed synthetic CDOs are rare because expertise in managing portfolios of credit derivatives is in short supply, according to structurers in London. AXA is one of the few fund companies that manages portfolios of credit-default swaps, according to London-based structurers.

Investors can buy into the transaction through credit-linked notes, rated AAA, AA, A and BBB, which make up 14% of the transaction. AXA will keep half of the 4% equity tranche and the other half will be sold. The remainder of the transaction will be sold as an unfunded credit-default swap. The average spread in the portfolio will be 125bps and 70-75% of the credits will be European-based companies with the rest coming from North America.

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