Deerfield Capital Management, INVESCO, American Express Asset Management (AMEX) and The Alcentra Group have joined the roster of managers seeking to raise collateralized loan obligations as financing costs plummet. In the last few months spreads on senior tranches have come in about 10-15 basis points and 50-150 basis points for mezzanine tranches with further drops expected.
But one underwriter said the cause and effect is not the cheap financing driving the demand, but delays in bringing deals to market tightening spreads. Underwriters stated that problems sourcing loan collateral are leading to delays warehousing assets, which in turn is sending investors in structured vehicles to the secondary CDO market. That leads to a run up in bids on these deals and that is driving the primary CDO market with it.
"Several people are quick to point out that CDO [spreads] are at or near historic tights--as though the tight CDO spread levels we see currently are not sustainable or justified," said Jeffrey Prince, an associate for Wachovia Securities CDO research group. But there is still further room for tightening. He believes, "the new 'norm' for AAA's, on a weighted average basis, could well be in the low [LIBOR plus] 40's by the time the dust settles."
The new vehicles will need this cheap money as spreads on leveraged loans stay low and secondary prices remain in the rafters. But Prince also stated that underwriters are adapting to the low arbitrage environment with structural tweaks. "[They] are structuring money-market tranches, extending the reinvestment period and/or extending ramp-up periods in hopes of getting cheaper collateral later or more opportunistically," he said. Another part of the equation has been lower expectations from equity investors. Another CDO structurer said returns of up to 15% are no longer realistic.
Stephen Bruce, Alcentra's cio; Anthony Clemente, managing director at INVESCO; Jonathan Trutter, Deerfield's cio; and Lynn Hopton, a senior managing director at AMEX, did not return calls. Credit Suisse First Boston is leading the Alcentra deal, Bank of America is marketing Deerfield's $415 million Long Grove and UBS is leading AMEX's $400 million Centurion VII. Wachovia is said to be marketing the $400 million INVESCO deal called Champlain.