Citigroup is working on a $500 million collateralized loan obligation for PIMCO that will invest in pro rata loans, only the second actively managed CDO to tap the much maligned revolver and "A" loan portion of the capital structure. The deal is said to mimic a structure Citi created earlier this year for TCW, said a source.
Pro rata loans are not usually considered a good investment for asset managers because the revolver may need to be funded and the undrawn spreads are too skinny. Instead, CLOs are dominated by "B" loans, which are fully funded and have higher spreads. But the vast source of pro rata loans offers a diversified and accessible pool of collateral, explained the source. "TCW saw an opportunity to make money on this when no one else was interested," said a loan pro. Officials at PIMCO and a Citi spokeswoman declined comment.
It could not be determined if the PIMCO deal uses the exact same structure as the TCW deal, but Vandana Sharma, an analyst at Standard & Poor's, explained how the quasi synthetic, hybrid cash-flow TCW deal works. The partially funded synthetic structure reduces the weighted average cost of the liabilities due to the fact that only $150 million of funded liabilities are issued against a reference portfolio, which is approximately $500 million, she explained.
The issuer synthetically invests in an actively managed reference portfolio of senior secured pro-rata loans. The issuer then enters into a swap agreement with Citi, whereby the bank will pass through the interest return and trading gains net of expenses, fees and trading losses back to the issuer.
On the liabilities side, the issuer assumes the losses up to the funded amount--in this case $150 million--of the liabilities. A super senior tranche takes the risk of loss above that level. Initially, the funded note proceeds are invested in a guaranteed investment contract provided by a triple-A counterparty. These are called eligible investments and are liquidated to repay the swap counterparty for losses up to the amount of the funded notes. The equity investors in the deal absorb the first $33 million of losses on the reference portfolio, while various classes of note investors bear any losses above the first $33 million up to $150 million. In return for bearing the first $33 million of risk, the equity investors receive the excess cash flows generated by the reference portfolio.