The first market-value collateralized debt obligation will hit the European markets this year, according to rating agency officials. They say the development is expected as managers seek greater flexibility in selecting assets to include in their structures and the rating agencies gain greater comfort from increased transparency in loan pricing. "Of the 19 or so CLOs we anticipate in 2005, one or two will be market-value," said Perry Inglis, European head of collateralized debt obligations at Standard & Poor's in London, who said the agency has been approached by several banks on the subject.
One of the European CDO managers considering funding based on market-value is London-based manager ICG, which has already issued six CDOs. "It would allow us to invest in a broader range of assets, in particular ones that would be excluded from regular CDOs, for instance for currency or rating reasons," said Sara Halbard, portfolio manager. She added ICG would evaluate not only loans but other assets as well, but declined to discuss whether the manager has immediate plans to launch a market-value CDO. Halbard remarked that a market-value approach has always been attractive to managers, but that the rating agencies have in the past not reached a sufficient level of comfort with certain structures.
A market-value structure allows a CDO manager to include assets that might not be acceptable in a traditional cash-flow CDO--for example assets with unpredictable cash flows. This is because the debt in a market-value CDO can be paid off with the proceeds from the sale of assets in the portfolio, rather than relying on the cash flows from those assets as in a traditional cash-flow CDO. A market-value structure further enables a manager to fund long-dated assets with short-dated paper for the same reason, which lowers the cost of funding.
Some market participants are skeptical that market-value structures will increase in popularity, especially in the loan market, as the asset class is still quite illiquid in Europe and lacks price differentiation. "You have to be able to mark the assets to market, and when most loans in Europe trade around 325 over and there's low volatility, that's pretty difficult," remarked one London-based analyst.