Barclays Capital has priced a $230 million market value (MV) collateralized loan obligation for Durham Asset Management called Credit Genesis 2005-1 that will enable the hedge fund to invest in stressed, distressed and par bank loans. Durham is highly unusual in tapping a MV deal, but JPMorgan's CDO research group is predicting an upswing in issuance of the once-maligned structures with up to 10 deals predicted by the end of the year.
"This structure lends itself to where we are in the credit cycle for this asset class," said TK Duggan, a managing principal at Durham. He explained that Credit Genesis is the hedge fund's first CLO. However, the firm has been involved in the distressed market since the mid '80s. "The credit cycle is starting all over again and in times of volatility and greater risk, the safest thing to buy is senior secured debt," he said.
Duggan believes the market-value structure is the only one that works for buying stressed, distressed and par bank loans. "We only have one test--a MV test--in a cash flow test, it would be unwieldy."
MV deals differ from cashflow CDOs as the assets are marked-to-market frequently. Asset values are then haircut based on asset and structure specific characteristics to determine maximum borrowings. The structures were popular in 1998 but credit volatility over the next few years forced liquidations in transactions and negative equity.
Since then structural improvements have been made and less suitable illiquid assets are unlikely to be included in the future. Now market-value CDOs are set for a comeback as they don't force managers into a long-only strategy and allow increased flexibility to generate alpha. Furthermore, as with all CDOs, issuers are benefiting from a cheap cost of funding.
According to one investor that recently passed on completing a deal, MV CDOs are not for everyone. Whereas a typical CLO will have 10-11 times leverage a MV CLO has lower leverage. "It's a bet that in return for buying par loans today, you're waiting for distressed to turnaround," said the investor. This suits Durham perfectly. Duggan explained the structure has a $100 million revolver that can take the leverage up and down, while the five-year deal will be actively managed.
