Credit Suisse First Boston has structured an innovative collateralized loan obligation for MJX Asset Management that adjusts more quickly to changes in the market value of loans than traditional CLOs and provides better protection to senior noteholders. The $250 million Vista Leveraged Income Fund, which priced at the end of last year, uses a market value-based asset coverage test instead of the more typical par-based over collateralization (OC) test.
"A practical implication is that a standard CLO is less sensitive to the market's assessment of credit riskas reflected in security prices. This market-value approach may lead to a more responsive structure that reacts more quickly to changes in perceived value," stated Ramon Torres, v.p. and senior analyst in Moody's Investors Service's CDO group. "However, it does expose the deal to a little more volatility," he added, commenting that in almost every other respect the transaction is a traditional cash flow CLO.
The senior notes may have somewhat better protection as negative market movements are more immediately translated into a delevering, he said. "On the flip side, the senior notes may find themselves exposed to reinvestment risk if their capital is returned due to unusual temporary periods of market volatility."
One of the operative structural features in a cash flow CLO is a set of coverage tests, which traditionally have been par-based, where one looks at how much par collateral there is in the deal, Torres explained. Based on certain test requirements, if the deal falls below that level of par collateralization, the deal requires the notes to be redeemed or amortized in order of their priorities. This is a way of reducing leverage when par collateralization goes down. But Vista is different in that it uses a market-value approach instead of a par-based coverage test.
There is some resistance to introducing market-value elements to cash flow CLOs, "This may have to do with the fact that the traditional approach has been one of credit risk, as measured by ratings implied default probabilities, rather than as measured by market value," Torres said. "This attempts to marry and balance both, though time will tell whether the market will be receptive." One particular nuance of this deal, that lends itself to the structure, is that it is looking at primarily liquid, senior secured loans for which there is now a deeper market and more availability of transparency as far as price discovery, said Torres. Hans Christensen, MJX's portfolio manager, referred questions to CSFB bankers, who declined comment.
