Highland Capital Management is significantly increasing the size of its second pro rata collateralized loan obligation, called Valhalla. A loan investor said the deal could be increased to $800 million, after being originally slated for $600 million. Highland is raising this second fund only months after completing the $550 million Bristol Bay CLO. A buysider said equity investors unable to participate in the first deal drove demand for the second. A Highland official declined comment.
Citibank arranged the first CLO and is also leading the latest vehicle, which uses synthetics to invest in revolvers and "A" loans. A Citibank spokesman did not return calls. Citibank worked with asset-management firm TCW last year to develop the structure, which enables institutional accounts to buy pro rata loans (LMW, 2/2/03). Since then Citibank has raised similar deals for PIMCO and Prudential Investments. Previously these loans were considered unattractive and unsuitable for non-bank investors, because they are partly unfunded.
This means the cost of the liabilities in a normal cash-flow CLO are too expensive to fund the investments, but Citibank found a way around this by issuing a super senior unfunded tranche. The issuer synthetically invests in an actively managed portfolio of pro-rata loans. The issuer then enters into a swap agreement with Citi, whereby the bank will be the buyer of protection on the portfolio of revolvers and term loans. The equity and then the funded notes take the first losses.