Citi touts auto supplier flatteners

In a recent high yield research report, Citi points out that steepening in credit default swap curves seems to have stopped and says this could be a good time to put on flatteners on some names. It recommends trades on American Axle and ArvinMeritor, two of the steepest names in the high yield index.

An equal weighted steepener in American Axle, where the investor sells five-year protection at 555 basis points and buys three-year protection at 365bp would be positive in roll-down, flat in carry, and would lock in two-year protection three years forward at 900bp. Investors would lose money if there is a liquidity event in years four or five, which Citi believes is unlikely. American Axle’s fortunes are closely tied to those of its biggest customer GM, which is seeing a rapid improvement in earnings. American Axle’s gross leverage is still high, at more than nine times, but Citi’s analysts believe it should fall to below four times by the end of the year. They reckon that credit default swap spreads could tighten to around 400bp.

ArvinMeritor is a relatively safe long given the strong recovery in the trucks segment, write the report’s authors, and could tighten 150bp from current spreads by the end of the year. Investors could put on a flattener by selling five year protection at 545bp and buying the same notional of three-year protection at 360bp.