Leveraged loan managers are increasingly turning to collateralized debt obligation structures that cater to equity and mezzanine investors' craving for more stable returns. These deals are structured so that if collateral suffers a principal loss there is an ability to call contingent capital into the deal through a swap, which enables the vehicle to stay fully invested longer. This capital is then reimbursed out of excess spread, explained Paul Forrester, a partner at law firm Mayer, Brown, Rowe & Maw.
Wachovia Securities' proprietary APEX vehicle is viewed as a forerunner of such structures, but others have popped up. "There are a number of transactions that are similar, including proprietary structures from Lehman Brothers and Citibank that operate similarly to the APEX credit default swap," Forrester said.
"I've seen more of these types of deals," reiterated Belinda Ghetti, a director with Standard & Poor's, who said in the past there would be an occasional APEX deal, but there have been six this year between Wachovia and Lehman. The equity as well as the mezzanine and senior note investors get more stable performance when interest proceeds are cut off from the equity to cover defaults, she commented.
In recent months, The Carlyle Group and Invesco Senior Secured Management have tapped Wachovia for the $400 million Carlyle High Yield Partners VI, and the $440 million Champlain I deals, respectively. Lehman did its first Par Structure vehicle in May for Putnam Investments' Boston Harbor CLO 2004-1 and since then has completed Gulf Stream Asset Management's Gulf Stream-Compass CLO 2004-1 and American Money Management Corp.'s AMMC CLO III.
Anthony Sciacca, director and head of CDO marketing and origination at Wachovia, said his shop as seen an increase in demand from both loan managers and investors in the APEX structure. "The primary benefit to APEX is that the manager can reduce or eliminate the need for BB liabilities and significantly increase the AAA liabilities, which have a cheaper cost, and which expands the available arbitrage," added Forrester. "Currently, the AAAs are also far easier to sell than the BBs as they are sold at a 30 basis point plus premium to LIBOR, whereas some corporates with the equivalent rating are able to sell debt at or even below LIBOR, he explained. "All managers should appreciate the opportunity to do a deal with no or fewer BB liabilities," he stated. Lehman's Par vehicle also eliminates BB liabilities, providing a more efficient capital structure, a banker said.
Not all managers are confident of using the vehicle though. One CLO investor said these deals can be a little bit more expensive as you have to pay a swap cost on top of the AAA. But he added that you can put more leverage into the deal. Forrester also believes there are more immediate benefits in the current environment. "The structure has a greater value to managers when spreads are tighter as the arbitrage opportunity is more critical," he notes.