Investors in U.S. synthetic high-yield collateralized loan obligations have been cashing out at a significant rate in the past year as a rebound in the loan market has put them back-in the money. Redemptions have increased significantly this past year, noted Michael Gerity, an analyst with Fitch Ratings. He said of the 45 or 50 deals rated by Fitch, about one-third have been redeemed and most of these have been in the past year.
Synthetic CLOs often consist of total rate of return swaps (TRS) that reference corporate senior secured loans. These deals include the Sequils/Mincs, and SERVES as well as some other privately rated deals, he explained. He declined to name private deals that have been redeemed. However, a number of portfolio auctions from managers such as AIG Global Investment Group and General Re-New England Asset Management have reportedly been a result of the KZH synthetic deals being liquidated (LMW, 6/14).
Many of these synthetic deals contain an optional redemption feature that allows investors to redeem their securities in whole or in part during the life of the deal or after a pre-determined lockout period, usually five years, noted Hedi Katz, also an analyst with Fitch. From 2000-2002 when loan prices, along with other corporate securities were depressed, investors who were eligible to redeem their notes were not incented to do so because they were out-of-the-money on the TRS, she explained. However, beginning in 2003 loan prices increased dramatically. Therefore, many investors are now in-the-money on their TRS and have been redeeming their notes in order to lock in gains.
Gerity also suggested that many of the investors in the TRS, such as insurance companies, may have inherited the investment through mergers and may no longer want it. As a result he believes that those that now hold the investment are more likely to continue to hold it as they are comfortable with the instrument. One manager was even able to extend and increase a synthetic deal.
Synthetic deals were more popular five or more years ago, but there have been very few in the last two years. Many investors may not understand the swap documentation or would rather stick to a plain cashflow deal, Gerity said. "I'd like to think they would come back, as prices have come back. But they tend to be pretty complex deals," he added.