The market for synthetic securitized products in Asia may have been slow to take off but now it seems barely a week passes without a new collateralized debt obligation (CDO) being issued. The latest such offering to be completed is a deal backed by $1 billion of credit default swaps that JPMorgan structured for DBS Bank and DBS Asset Management.
JPMorgan and DBS Bank jointly underwrote the transaction, with DBS's asset management arm acting as collateral manager for the underlying portfolio. Allen & Overy provided the legal counsel to the arranger.
The portfolio is linked to 100 credit default swaps from a mix of mostly European (45% of the total), North American (35%) and Asian borrowers (17% including Australasia) with an average rating of Baa1. The reference entities come from a diverse range of industries including telecoms, banking, insurance, oil and gas, publishing and electronics.
After the composition of the asset pool was finalized, the lead managers then sold $95 million of seven-year bonds, issued out of the Merlion CDO 1 special purpose vehicle. The bonds were split into four tranches including $50 million of senior notes, rated Aaa by Moody's, $15 million of Aa2 rated notes, a $10 million A2 rated tranche and $20 million of Baa2 rated bonds.
In addition, the transaction has been structured with an unrated $30 million equity piece - to be sold at a later date, probably to European investors - which will pay potential investors any excess spread accrued on the deal.
Given that pricing information on CDOs is often about as easy to come by as a needle in an extremely large stack of hay - for example, DBS' rival United Overseas Bank has declined to offer any details about the three CDOs it has completed - it was refreshing to see the parties involved on Merlion CDO 1 decide to be more open about their deal.
Consequently, we are able to learn that the spread on the Aaa notes was 65bp over Libor, 140bp for the Aa2 bonds, 225bp for the A2 tranche - which would rise to 325bp should Moody's downgrade the bonds to Baa1 or lower - and 350bp for the Baa2 notes.
In addition, a source familiar with the deal deemed the pricing to be in line with current market spreads, while adding that all the tranches were placed into Singaporean accounts.
Although this was DBS' first venture into the arbitrage market, the bank was actually a pioneer for synthetic securitization in Asia when it completed in December 2001 a S$ 224 million ($129 million) collateralized loan obligation with JPMorgan again involved as joint lead manager.
DBS was the first ex-Japan Asian bank to issue a synthetic balance sheet securitization, which enabled it to manage its capital ratios more efficiently. The 100% risk weighting of a portion of its corporate loan portfolio was reduced by moving credit risk off-balance sheet and into an SPV. As a result, DBS was able to commit less capital to cover default risk on the loans and in the process improve its capital ratios through enhanced capital treatment.
At the time, it was predicted that other Asian financial institutions would follow DBS' lead but the reality has been somewhat different. While Japanese banks have been regular users of this tool, their counterparts in ex-Japan Asia have not been as keen to come forward. The most plausible explanation for this is that for balance sheet CDOs the issuer must sell all the tranches, a potentially challenging exercise for many institutions.