The messy, public lawsuit between Barclays Capital/HSH Nordbank over the German bank's collateralized debt obligation losses has actually had the surprising effect of increasing interest in the use of synthetic reference obligations. The case, which was over $151 million HSH invested in synthetic CDOs via Barclays, was recently settled out of court for undisclosed terms and received significant coverage from the mainstream press. That piqued the interest of more players. Inquiries on synthetic assets have picked up as a result of the case even though HSH sued Barclays for losses it incurred, one banker told BW. And because most dealers now make markets on a variety of prominent asset-backed names across the capital structure, bankers and investors said they are looking more at using synthetic exposure as a substitute for cash bonds, particularly in asset-backed CDOs,
Chris Ricciardi, managing director and head of the structured credit group at Merrill Lynch, noted synthetics could be useful to offset the expected drop in cash supply, which is likely to occur in the mortgage-heavy ABS market if interest rates rise significantly.
The use of synthetic ABS in CDOs is becoming more prominent even without standardized documentation from the International Swaps and Derivatives Association. As a result, investors need to be diligent in reading the fine print and determining what the terms of their contract are, according to panelists. "We haven't reconciled the marketing spin and the actual terms" in some cases, said James Rothman, managing director at ACA Capital.