Structured credit tastes good (but beware the chef!)

The recipe is not straightforward as the ingredients have become complex: tight spreads, low default rate, steep credit curves, low level of equity correlation, flat interest rates. Add a spice of new regulatory environment (IFRS, Basel II) and you come up with the challenges facing CDO investment bankers, asset managers and the investors, usually starving for yield in this second quarter of 2006.

Some complain about the market environment. Plenty of others grasp the opportunities that it creates! Looking at the recent striking growth of structured credit product issuance, there are many popular 'dishes' in the market. An increasing number of players are involved in all geographies (eastern Europe, Australasia, India, South America are emerging as regions where products are distributed) and across many more client segments (corporate, retail).

Let's look at the favourites most commonly ordered recently:

• Long/short credit plays: Usually unfashionable because of the inherent cost of the short bucket, these have become popular since spreads have reached their historical lows. Also, the new IFRS constraint has led investors to focus on products that maximise return and minimise mark-to-market volatility. This trend has contributed to trigger waves of long/short combo notes, which happen to be very stable in terms of secondary market prices in most market scenarios.

• Forward CDOs: The ability to benefit from the steep curve environment is a feature of forward CDOs, which have turned out to be much more than amuse-bouches. The development of this new product category opens new grounds for the next few months to come. Investors have been very keen to consider the new dish, which has triggered a lot of volume, especially from investors who had put investments on hold given the tight market environment.

• Credit CPPI/VPPI: While it was a familiar dish for equity investors, the CPPI product range was commonly ordered by credit investors. However, it turned out that there were many investors who were eligible to total return products referenced to a credit portfolio. While the product bears no (or limited) stated coupon, the investor can benefit from an attractive leverage while still benefiting from full capital protection. Calyon successfully launched OCEAN, a CPPI managed by Axa Investment Managers, which turned out to become a benchmark transaction in the managed credit CPPI product category.

• Hybrid opportunities: The recent volatility experienced in the commodities market has led to the cooking up of new opportunities for CDO investors. Indeed, similar to what had been done with deep out-of-the-money options (equity default swaps) two years ago, a few innovative chefs decided to mix flavours. CALYON created ALCHEMY, a structured finance product providing exposure to a hybrid portfolio composed of both commodities: deep out-of-the-money put options (commodity trigger swaps) and high-grade credit default swaps. The product, whose marketing was in progress at time of press, seems to be very well appreciated by the clients, showing that innovative cuisine can lead to great results, provided that the clients' objectives are met.

• Cash CDO frenzy: Besides the activity in the synthetic space, the cash CDO products, especially focused around leveraged loans and ABS, do appear regularly on the best cuisine's menus. On the loan side, Calyon is currently bringing to market a EUR2.2 billion multi-managed leveraged loan fund called Confluents, where five different CLO managers and a fund-of-fund manager (CAAM Multi-Management) are involved. On the ABS side, the latest developments of CDS on ABS have facilitated the execution of 'hybrid' ABS CDOs mixing cash and synthetic ABS assets.

The above shows that the structured credit market is full of new flavours, combining the old classics, current cooking constraints and the new ingredients available. As in every three-star restaurant, you can either have value for your money or be disappointed. It all depends on the chef's creativity, reliability and long-term commitment to their business.

The Structured Credit team at CALYON is working every day so that our clients will view their chef as a long-term partner in the credit space.

Loic Fery,
Managing Director,
Global Head of Structured Credit & CDOs
CALYON Corporate & Investment Bank
+ 44 207 214 66 43
[e-mail]

As of April 2006, Calyon Structured Credit & CDO team includes over 110 professionals globally, dedicated to synthetic (correlation products, CPPI) and cash structures (cash CDO; credit funds).

In addition to investment opportunities, Calyon Structured Credit team also provides investors with solutions tailored to their specific needs (portfolio restructuring, IFRS or Basel II solutions). In 2005, CALYON Structured Credit ranked 2nd in Global Managed Synthetic CDOs.

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