Radian Eyes Exotic CDO Instruments
Radian Asset Assurance is looking to invest in forward starting synthetic collateralized debt obligations as a way of increasing the spread it is paid for taking CDO exposure.
Radian Asset Assurance is looking to invest in forward starting synthetic collateralized debt obligations as a way of increasing the spread it is paid for taking CDO exposure. Bankers said these instruments are rarely used, but could become more popular as investors search for yield because they can be structured so as to start receiving payment streams at the start of the forward contract.
The advantage of entering a forward starting trade is the credit curve is steep so you get paid a higher spread than on a CDO starting today, said Hao Wu, managing director in global structured products at Radian in New York. The credit curve is steep because market participants are forecasting an increase in default rates. The interest in forward starting swaps is part of Radian's plans to increase the amount of CDO and structured finance exposure it takes this year by 40% to USD7 billion (notional).
Lee McGinty, head of credit derivatives strategy at JPMorgan in London, said, "The market is pricing in quite high forward spreads and you could take the view that they are unlikely to be as high when we get there." He added that because the investor is locked into the rates any extra spread should be seen as a risk premium.
Wu said Radian will execute the trades if it can agree on a portfolio and spread with a dealer. The monoline trades with around 20 counterparties last year, but Wu said it is hoping to increase that number.
Although the forward starting trades have more risk because they are longer dated trades, Wu believes the wider spread compensates Radian. In addition, because it invests at the AAA level he is comfortable with the level of risk.