Market participants welcomed the ninth series of the North American Investment Grade CDX index (CDX.IG.NA series 9) last Thursday with high expectations, specifically with the addition of better quality and retail-heavy names.
"We have seen the inclusion of safer' names across the indices, likely owing to the market's flight-to-quality bid in light of recent turmoil," said analysts at independent credit research firm CreditSights, adding that only two of the newest additions, Liz Claiborne and Quest Diagnostics, have a higher mean credit risk estimate than the names they are replacing. The estimate is part of the company's BondScore product used for default and relative-value prediction.
At the same time, the on-the-run index has shed some of its LBO-related names, including Alltel Corp., First Data Corp., Boston Scientific Corp., Expedia and Residential Capital Corp., as well as Olin Corp., Temple-Inland and Tyson Foods. In their place, it took on such retail names as The Home Depot, Darden Restaurants, Liz Claiborne and Fortune Brands. Other new additions include Gannett Co., Bello Corp. and iStar Financial.
For the investment-grade index, the new series will be significantly credit positive, said Nishul Saperia, CDX product manager at Markit. "This is going to be a fairly pronounced roll relative to others, and we should see the new index trading significantly tighter than series eight," he said, noting that typically with an investment grade roll, all of the names that have been downgraded are removed and replaced with names that are investment grade. For instance, Residential Capital has been replaced in the new IG index and will now trade on the CDX HY series nine index instead. The credit has encountered serious difficulties as a result of the current climate in the housing market and has been trading at extremely distressed levels but remains in CDX IG series eight.
Trading on the index closed with a spread of 50 after its first day. While it was tighter than series eight, it is hard to discern initial market noise from the actual roll changes, market participants agreed.
And trading on the CDX.IG.NA series nine will be strong, market participants predicted, partially because the liquidity that dropped in some of the indices in August is now back.
While market volatility remains, it is not so great that people are scared of trading, which contributed to the summer lull.
Within the first week or two after the roll, Saperia expects to see more than 75% of the investors in series eight move to series nine since - unless the indices change drastically - the new index is where liquidity is concentrated. While there are some significant changes to the new index, they are not as significant as they were between series four and five when GMAC and Ford Motor Credit were removed, two of the biggest credits in the market.
Better Credit For
The credit quality of the ninth series of the North American High Yield CDX index (CDX.NA.HY Series 9), which is set to launch on Sept. 27, will also be improved by some new names. In fact, all of the new additions were of a higher credit quality than the existing group, except for Tribune Co., according to CreditSights.
Included in the new HY on-the-run index are Alltel Corp., First Data Corp., Realogy Corp., Community Health Systems, Freeport-McMoRan Copper & Gold and Residential Capital.
On the flip side, Delhaize America, Huntsman International, Lucent Technologies, Parker Drilling Co., Reynolds American, Solectron Corp. and Triad Hospitals will be removed from the index.
Despite the improvement in corporate credit quality, however, Citigroup Global Markets cited LBOs such as Alltel, First Data and Realogy as additions that would shake up the mix. "We could see HYCDX widen by 30 to 50 basis points on the roll," Citigroup said.
Residential Capital may not be a volatile name in the long term, but it has been for the past several months - and probably will be for the next couple of months, said a high yield bank analyst. He also expected the addition of Tribune to heighten index volatility along with other pending LBOs.
"If we had a bunch of big levered LBOs that already closed, you might not see the volatility. A lot of volatility around these names gets centered on what level is this thing ultimately going to end up pricing at," the bank analyst said. Tribune, Alltel and First Data will all join the index before the completion of their buyouts.
Further, First Data is still an investment-grade company, though it is expected to be a high yield name by the time the roll goes through at the end of the month. "You had a lot of trading in First Data initially on whether the deal would go through, and now you have got a little jockeying on First Data in terms of what is the market clearing level," the analyst added.
However, not all analysts expected the same volatility and spread widening.
CreditSights expected both of the new indices to trade tighter than the previous series. Indeed, many of the LBO names in the new HY index are fallen angels from the previous IG index. As a result, products such as CPDOs that depend on releveraging in widening markets to maintain sufficient capital could run into some problems, the research firm said.
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