Collateralized loan obligation managers are starting to use synthetic exposures to indices as a means of generating yield as tight spreads and an active loan community pose challenges to sourcing loans for new deals. Managers such as Credit Suisse Asset Management are using the strategy to avoid drifting down the yield curve the market to fill deals, according to Derivatives Week, an LMW sister publication.
David Tesher, managing director at Standard & Poor's in New York, said the ratings agency saw the first such deal hit the market in December and several more are in the pipeline. Managers are also looking to purchase exposures to synthetic indices in case loan prepayment results in surplus cash, he added.
The trend is emerging as loans become increasingly difficult to source, said Tesher. Managers have begun structuring credit linked notes referencing synthetic high-yield indices, such as Credit Suisse First Boston's Select Aggregate Market Index "SAMI" (Secured) index. Tesher expects that other high-yield indices, such as TRAC-X or iBoxx, may also be used.
Nik Khakee, director at S&P in New York, added that the notes offer greater flexibility because they give managers time to be more selective when ramping up their portfolio. The strategy does, however, pose mark-to-market risks because when the manager buys more loans, they will need to sell some of their position in the credit linked notes and this may come with a trading loss, depending on the underlying index, he said.