CSO equity investors line up deals amid dispersion threat

Dan Alderson

Deputy editor

Synthetic bespoke tranche issuance has hit an impasse in recent months, denting projections for overall 2022 business at the mid-year point. But unlike the covid sell-off of 2020, wider spreads have created a queue of buyers ready to drive deals if conditions align.

“Demand to do bespokes is there, including investors who are keen to take equity,” says Sukho Lee, head of credit correlation at Nomura. “But volatility and concern about a downturn mean people are assessing factors such as dispersion, decompression and defaults. We could see a flurry of prints later this year when the timing is right.”

There were $10-15 billion of CSOs in the first quarter, leading some to posit around $40 billion of 2022 primary volume — a big improvement on the past two years. But Russia’s invasion of Ukraine and subsequent inflation-led volatility has stalled issuance. Nevertheless, interest is rising, along with the use cases of a tailored approach in a turning cycle. And strategists at various firms believe the market is pricing in rates risk with increasing accuracy.

“People are assessing factors such as dispersion and defaults”

Sukho Lee, Head of credit correlation | Nomura

A concern is that dispersion and defaults could shift risk down the capital structure. So far these have remained low in systemic widening that has made senior tranches stickier than equity. But a slowing economy, rising costs and borrowers’ lower funding access could increase focus on dispersion in the same way investment grade/high yield decompression has become a crowded trade.

For CSO investors, this makes length of exposure and prospective curve changes big considerations. But it also increases the appeal of more selective trades over indices — which are highly reactive to macro moves — and standard index tranches.

Given the sharp rise in CDS index spreads, there are better alternatives than index tranches for expressing views on dispersion, according to Tom Payne, head of Emea structuring at UBS. “With iTraxx Europe wide of 100bp, you’re better off going long the index and going short select single names,” he says.

A shift between systemic and idiosyncratic risk outlooks could mean bespoke volume quickly picks up if the market hits an inflection point.

“Bespokes allow investors to customise exposure and be name selective,” says London-based Lee. “The preference is for a blend of wider investment grade and safer high yield names. Alongside typical three-year demand we’ve seen interest for one-year trades, which is unusual, but mitigates dispersion risk.”

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Global credit funds & CLO's

July 2022 | Issue 247

Published in London & New York.