Credit structures abound

New angles

Yield-hungry institutional investors in Asia are turning to increasingly complex structured credit products to boost returns amid low interest rates and under-performing stock markets around the region.

One of the most recent innovations allows investors to take a view on a basket of three different rated credits for varying durations. So, unlike a first-to-default structure, which gives the investor exposure to a basket of credits until one reference entity defaults, this structure gives the investor exposure to all three credits for the first two years, the two highest-rated credits for the next two or three years, and the best-rated name for the remainder of the investment.

The structure is designed to cater for investors that want the yield pick-up that a lower-rated credit offers, but are unable or unwilling to take exposure to that credit for the full term of the investment. So, after two years, the most risky credit drops out of the basket. After another few years, the next lowest-rated credit drops out, leaving the investor with an exposure to a high-rated credit until maturity.

UBS Warburg has been marketing its version of the product – dubbed wedding cake because of its tiered structure – to investors in the region for the past few months. For example, the basket may contain exposure to General Motors Acceptance Corp (rated BBB+ by ratings agency Standard & Poor’s), The Republic of Korea (rated A–) and GE Capital (rated AAA).

However, the investor receives an enhanced return throughout the life of the investment, despite the fact that the most risky credit, in this case, General Motors Acceptance Corp, is removed after two years, says Philip Tsao, managing director and joint head of debt capital markets group, Asia, at UBS Warburg in Hong Kong. “The investor gets to utilise short-dated credit lines to weaker credits and still enjoy the higher interest yields on longer-dated notes.”

Deutsche Bank is also marketing this structure to investors in the region, which it calls the credit optimiser, and has completed several deals in the past couple of months. With credit spreads in Asia still significantly tighter than similar-rated credits in the US and Europe, this structure allows investors to benefit from bundling the credits together in a portfolio, says David Lynne, managing director and co-head of local fixed-income and derivatives trading at Deutsche in Singapore. “It gives the customer the ability to have exposure to two or three names they want to have. It also allows them to get a pick-up over any single name in the basket,” he says.

Lynne adds that many investors in Asia may not have internal approval to invest in lower-rated credits individually, but still want to benefit from enhanced returns these names offer. By including the more risky names as part of a basket, the overall rating is higher, making it more palatable for the investor. “The client may not be able to buy the poorer credit individually, or it’s not available for a shorter duration,” he adds.

The product is expected to be particularly popular among investors in Singapore and South Korea, who have demonstrated a voracious appetite for structured credit products, such as credit-linked notes with embedded range accruals, over the past few months (see this month’s Risk Management for Investors supplement, page S4). NS

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