Leveraged super-senior collateralized debt obligations, a popular innovation in the corporate synthetic CDO market over the past year, are taking off in the commercial mortgage-backed securities market with Wachovia, Goldman Sachs and BlackRock all set to hit the market with such deals.
Wachovia's Harbor CDO 2006-1 references USD2 billion of AAA-rated CMBS credit-default swaps that are part of the firm's own portfolio. BlackRock is also working on a USD500 million deal, Kimberlite Real Estate CDO 2006-1, and Goldman Sachs is preparing a USD700 million transaction from its Abacus shelf. Officials at the firms either declined to comment or did not return calls.
Rating agency analysts have been fielding inquiries from more banks that want to reference specific portfolios. CMBS has a more bullet-like cash flow than RMBS and ABS, making it easier to predict cash flows. Many leveraged super senior investors, which started investing in leveraged super senior tranches of ABS deals in the past year, have migrated to CMBS. The pricing on these first LSS CMBS deals has also been tighter compared to ABS, traders said.
The Wachovia transaction was prompted by reverse inquiries from investors and is backed by a mix of junior and senior AAA-rated bonds, a firm official said. "Investors come to us and say, 'Instead of buying bonds from a conduit where reserves and underwriting standards are coming down, I'd like to have access to all AAA and lever it up,'" said one banker who has structured such a deal. These transactions are typically privately placed.
Leveraged super senior CDOs are bespoke deals that are funded via a bank's own balance sheet. The leverage provides investors with higher returns without diluting the tranche's high credit rating. Leveraged super senior deals typically include early unwind triggers, which can cause the underlying CDS contract to terminate and settle the deal early. A combination of both loss and spread triggers can be attached to the tranche to satisfy both protection buyers, who prefer loss, and dealers, who prefer mark-to-market valuations. Evaluating the attachment points is what drives modeling and pricing.
