Further surge in investment grade synthetic CDO issuance expected, says BofA

The US bank made the prediction using its proprietary ‘return-on-equity barometer’ measure - an index of both volumes and the attractiveness of buying CDO equity in the new issues market.

It estimated that the internal rate of return on synthetic investment grade CDOs has reached 45.9% and 34.6%, assuming a 0.25% and 1% constant annual default rate, respectively.

Increased synthetic issuance should cause the default swap market to be better offered, implying that some credits currently trading at wide spreads will experience some technically induced tightening, said Lang Gibson, New York-based director of structured credit products research at Bank of America, who co-authored the US bank’s latest Structured Credit Strategy research note with Erin McCutcheon.

So far there has been $84.9 billion worth of synthetic CDO issuance this year, compared with $35.3 billion in the cash market. Static and managed deals account for 45% and 16%, respectively, of synthetic volumes for the year-to-date. Balance sheet deals make up the remaining 39%.

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