"It took a bit of time for investors to digest everything that has happened but in the last few weeks we have seen requests from investors coming back into structured credit," says Francois de-Supervielle, head of structured credit at Societe Generale Corporate & Investment Banking in Hong Kong. "It's still a difficult market right now but it's starting to get better."
De-Supervielle says that investors will come back slowly and will be much more selective than they were before the credit crunch, focusing on basic structures that are more transparent and easier to understand than the complex products that were at the centre of the subprime blowout.
The most common requests from investors such as banks and insurers are for first-to-default basket swaps, which provide exposure to a group of corporate credits û typically well-known investment-grade names.
"In a way it makes sense for investors who are already taking credit risk on bonds in their own book," says de-Supervielle. "They're already comfortable with this risk so they can try to leverage a little bit by combining and doing a first-to-default swap."
It is not only institutions that are interested in buying back into the structured credit market, but also private banks and retail distributors. Again, the focus will be on good quality names that are familiar to regular investors. No trades have yet been completed but de-Supervielle says SG expects to bring some deals to the market by June.
Spreads have tightened, but are still wide enough to offer attractive yields from relatively simple structures. A five-year basket of four or five investment-grade credit default swaps can earn investors a return of 200bp to 250bp, and adding some beleaguered financial names can juice those returns even more.
The continued volatility in equity markets is helping too. As investors search for other places to park their capital, some are starting to realise that the size and scope of the credit sell-off was irrational given the low level of corporate defaults, particularly in Asia.
Spreads on the main iTraxx index of investment-grade names spiked to 160bp in mid-March but have since settled back to the 70bp mark, which is roughly where they started the year but still much more generous than a year ago. In those carefree days, before subprime was a household word, spreads were down to just 20bp, which is why so many structured credit investors lost out û as yields fell, investors simply put on more leverage. So, when spreads tripled, investors with 10- or 15-times leverage were exposed to huge mark-to-market losses.
"Investors had got greedy for yield and forgot that more yield meant more leverage," says de-Supervielle. "They just focused on the yield and the rating, and tended to forget that the rating doesn't address the mark-to-market volatility."
Convincing those investors to buy CDOs again may take some time û they will probably have to be re-invented with another name. Just as junk bonds were re-named high-yield bonds and became more popular than ever, CDOs or something like them will likely come back even stronger now that the market has a better understanding of how periods of extreme stress affect valuations.
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