First-loss pieces of collateralized debt obligations have changed hands recently in a new development that is seeing the market's growing liquidity extend to all parts of the capital structure. Although the equity classes are intended to be a buy-and-hold investment, traders said they are increasingly receiving interest from investors, mainly from the hedge fund community, looking to pick up yield. "Demand for every rated note is very high and they are looking a little further down," said one trader.
CDO equity can be difficult to source given the limited amount sold. Although a recent collateralized loan obligation managed by Friedberg Milstein included a roughly $120 million equity chunk, most transactions include only a small amount of equity. This puts a ceiling on just how much of a secondary market will ever develop, one researcher stressed. To be sure, only a small amount at a time is being moved. "The trading being done is $3-5 million slices. It's gone from zero to a few slices here and there," the trader said.
Beyond the extra yield, equity holders get voting rights in a deal and can force changes such as a liquidation of assets, which in many deals is attractive given current spread levels and maybe another reason why aggressive hedge funds would want to acquire equity. While deal indentures vary, most generally require two thirds of equity holders, excluding the manager's portion, to approve a major change such as a liquidation of the vehicle. "It's another reason to scoop up equity. You can buy the mezzanine at a 10% discount and then buy the equity and call the deal," noted one trader.