First-loss pieces of collateralized debt obligations have changed hands recently for the first time, in a development that shows the market's growing liquidity extends to all parts of the capital structure. Although the equity classes are intended to be a buy-and-hold investment, traders say 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. He declined to name classes that have traded or specify hedge funds that have expressed interest in picking up these assets.
CDO equity, of course, is difficult to source given the limited amount of it sold as part of an overall transaction. 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, since it is often the most difficult to place. 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 in $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 may be 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, must vote 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.