Credit Suisse launches latest version of Cedo

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Credit Suisse has launched the fourth series of its collateralised equity and debt obligation (Cedo) transactions, this time introducing two asset managers to manage the reference portfolios. Credit Suisse Asset Management will act as the primary asset manager, with a special tranche aimed at Spanish investors managed by Ahorro Corporacion, an investment services firm whose shareholders include Spain's savings banks and the Spanish Confederation of Savings Banks.

Credit Suisse has placed $750 million of notes, split into 15 tranches rated Aaa to A3 by Moody's Investors Service. The majority of the notes were placed with European investors, although the product was also marketed in North America for the first time, with between 5% and 10% of the deal placed with US structured credit investors.

Credit Suisse launched its first Cedo transaction - effectively a collateralised debt obligation (CDO) referenced to out-of-the-money equity barrier options - in May last year (Risk June 2005, pages 53-54). Unlike CDOs referenced to credit default swaps, where investors lose money if enough of the reference entities within the portfolio default, the barrier options - or equity default swaps (EDSs) - are triggered when the reference entity's share price falls below a predetermined barrier, usually 30-35% of its initial value.

In contrast to previous deals employing EDSs, the Cedo product is made up of two similar portfolios - one long (the risk portfolio) and one short (the insurance portfolio). The idea is that in a crash scenario, the losses caused by stock prices dropping below the 35% barrier will be offset by the EDSs in the insurance portfolio, which will come into the money once they reach 35% of their initial value.

Unlike the three previous transactions, Cedo IV will be actively managed in an attempt to create additional value for investors. "The main reason for having a manager is what happens if there is an Enron in the risk portfolio? Investors would either have to sell the note or wait until the share price hits the barrier. With this product, the manager can take action early," explains Stephane Diederich, head of structured distribution to institutional clients in Europe at Credit Suisse. "This is really a second-generation product and involved significant developments in technology to allow the active management of the portfolios."

Like synthetic CDOs referenced to credit default swaps, the managers have trading constraints imposed by the rating agency. They cannot trade more than 20% of each of the risk and insurance portfolios each year, and the substitutions cannot cause the downgrade of any tranche. All substitutions made in the risk portfolio must have the same or higher rating, and all trades in the insurance portfolio must have the same or worse rating. While the managers will start off with identical reference portfolios, they will diverge over time as they make different trading decisions.

"We looked for asset managers with both equity and credit backgrounds when structuring this product," continues Diederich. "The managers need to be able to monitor both the share price movements, as well as credit ratings migration for individual names in the portfolio."

- Nick Sawyer.

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