Bespoke collateralized debt obligations with five-year tenors have returned to the structured credit stage after a drought of several months. At least two large transactions have been issued this month and credit officials say they mark a comeback for that spot in the curve since dealers all but abandoned it chasing fatter seven- and 10-year returns.
The shift back has been prompted by the imminent change in Standard & Poor's rating methodology, which has made it easier to get attractive ratings for CDOs with less subordination. Dealers said the return of deep five-year liquidity will feed investors who have a preference for implementing credit views on shorter horizons. "There is a universe of investors out there who don't invest beyond five years," said one buyside official, adding the five-year structures are a hot topic on the street.
Another strategist said the five-year issues had a ripple effect on five-year iTraxx correlation in early March as dealers offset their positions through the index tranche market. The five-year, 3-6% tranche tightened to around 70-72 basis points from the mid 80s in February and the five-year 0-3% slice widened out by a couple of bps early in the week. "This could also be pre-emptive with people hedging before they put out new five-year deals," he added. It could not be determined which houses printed this month's private, most likely reverse inquiry, transactions. Deal sizes could also not be ascertained.
S&P's new Evaluator3, allows dealers to pay higher returns on shorter dated, investment-grade tranches because they require less subordination (DW, 1/13). "Five-year spreads benefit most on a relative basis," wrote Lorenzo Isla, head of European structured credit strategy at Barclays Capital in London, in a recent report. He noted AAA-rated portfolios now require 3.6% rather than 4.7% subordination. This picks up yield at high ratings, without requiring structures go out to seven or 10 years to get extra return.
