High stakes promise big year for new short-dated CSOs

Dan Alderson

Deputy editor

The bespoke tranche market looks set to put in revitalised issuance numbers in 2022 as interest grows in structured assets. But a clear trend is emerging for investors to assume short-dated exposure amid increasing macro and geopolitical uncertainty.

One-year bespokes have become the flavour of recent weeks, with equity investors especially preferring this duration to the more traditional two- and three-year exposures that previously characterised CSOs.

“Shorter dated bespoke deals are coming up more since equity tranche interest is more for near-term default risk,” says Cara Roche, portfolio manager at Zais Group. “This makes sense as there are good fundamentals, with an uptick in volatility but no uptick in defaults.”

Overall CSO issuance prospects look positive. Projected issuance in 2022 is $30-40 billion, which is approaching pre-pandemic levels.

“Bespokes volumes are picking up due in part to wider spreads, flattish front end curves, and lower equity correlations,” says Kelley Baum, head of credit derivatives at III.

“Fundamentals are good, with an uptick in volatility but not in defaults”

Cara Roche, Portfolio manager | Zais Group

“We’ve seen more transactions happening with one- to three-year maturities this year, and that may lead to more secondary market trading, and rolling trades.”

One opportunity afforded by volatile markets is that investors can obtain high all-in yields — a factor boosting index tranches but also the viability of CSOs.

In particular, volatility has made bespoke equity tranches attractive, since investors can avoid risky single names and achieve strong returns even if portfolios maintain the now-customary 70:30 split between investment grade and high yield.

“Correlation has come down a bit and that pushes risk into the lower part of the cap stack,” says Roche.

“It depends on your view on portfolio composition and moneyness, but it makes equity and junior mezz more attractive. Senior and senior mezz could still be a good long, but are better shorts than they have been.”

This in turn has given other investors reason to examine the senior part at a time when options can look expensive.

“Senior tranche correlations were very low going into the recent widening, but have gone up slightly as people search for convex hedges,” says Baum. “They may be better tail hedges than out-of-the money options given tranche duration.”

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Global credit funds & CLO's

March 2022 | Issue 243

Published in London & New York.