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Derivatives

Merrill Lynch Plots Course For First Shipping CDO

Merrill Lynch is conducting a feasibility study into structuring the first synthetic collateralized debt obligation referenced to shipping loans. The firm is looking at structuring the deal on behalf of a third party bank, which has a USD1 billion portfolio of shipping loans and wants to remove credit risk from its balance sheet, according to an official familiar with the deal. Bankers at Merrill declined comment.

The outcome of the feasibility study will depend on investor demand and the reaction of the rating agencies. Investors are expected to be similar to those that bought into the Leonardo deal on aircraft loans put together by Merrill Lynch and IntesaBci (DW, 4/29). One CDO investor said a shipping CDO would be an exciting deal as it would give exposure to an industry in which most banks do not participate, adding that he would likely invest in the transaction.

The study will also look at what proportion of loans are suitable for inclusion in the deal. The expected size of the CDO is likely to be much smaller than the USD1 billion portfolio. The average maturity of loans in the portfolio is five years and this is also expected to be the maturity of the CDO.

There is a wide variety of contracts and types of ships. However, the official said the diversity can also been seen as an advantage because it reduces the correlation of defaults. For example, demand for oil tankers will be affected by oil prices whereas demand for tourist ferries will be affected by general economic prosperity. Another potential problem is that few shipping companies are rated, but the official said this can be overcome by supplying extensive historical performance data on each of the credits. Brian Kane, associate director in the structured finance group at Standard & Poor's in London, said synthetic CDOs referenced to shipping loans are an extension of the aircraft deals and would be rated in conjunction with its transportation specialist to overcome the problem of the lack of ratings.

In a typical shipping loan a special purpose vehicle, set up by a shipping company, buys a vessel with a secured loan. It repays that loan using money it generates from leasing the vessel in the spot market, long-term charters or a mixture of both. The risk is that it will not generate enough money to cover the loan repayments.

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