Kevin Petrovcik is the product manager for INVESCO's bank loan and CDO group and the chair of The Loan Syndications and Trading Association's CDO group. He is responsible for the ongoing product development, structuring and marketing of new investment funds for the INVESCO group, which manages over $5 billion in bank loan and high-yield bond assets, including over 10 CDO structures. The LSTA established the CDO committee last year to identify and address specific issues relating to collateralized loan obligations and collateralized debt obligations within the syndicated loan marketplace.
LMW: What has been achieved since inception of the CDO committee and can you highlight the most recent accomplishments?
Since establishing the committee last year, the primary focus has been consolidation and accounting issues. Specifically, the CDO committee has focused on FASB consolidation issues for Special Purpose Entities (SPE). Last summer, the committee responded to the FASB's Exposure Draft on the Consolidation of Certain Special-Purpose Entities, and last fall, we participated in the FASB's SPE roundtable discussions. Currently, the committee has been working with members and the major accounting firms in providing guidance on CDO consolidation issues.
LMW: Do you think the new FASB Fin 46 Standard will force collateral managers to consolidate assets onto their balance sheets and what will be the effect of this?
The impact of FASB FIN 46 has yet to be determined. Originally in our position paper and during the roundtable discussions, the CDO committee was looking for FASB to carve-out CDOs from the proposal. Our position is that consolidation does not fairly represent the assets and liabilities of the underlying entities. We believe that market value CDOs fulfill the goal of dispersing risks and rewards into identifiable financial components (in the class of debt offered and rated) and that the risks are effectively dispersed to various entities on a non-recourse basis. Furthermore, no one entity has the ability to direct all significant activities of these SPEs. Instead, actively managed CDOs, while not the target of FASB, have become an unintended victim. We now need the accounting firms to agree on how to handle consolidation of CDOs from both a manager and an investor perspective.
LMW: What has driven the growth of CLO vehicles as participants in the loan market?
The CLO product is a credit arbitrage investment that eliminates, to a large extent, market risks, such as interest rate risk, which makes these investments very attractive. CLOs offer investors two additional advantages. First is diversity. By pooling together a large number of higher risk assets, the risk/return profile of the pool is better than on a stand-alone basis. The second advantage, as mentioned above, is bifurcation of risk. The CDO structure enables investors to purchase varying degrees of risk based upon the same underlying collateral pool. CDOs fit into various investment baskets of the traditional institutional investor or high net worth client. Most often, they are part of an investor's fixed income or alternative strategy.
LMW: Are we seeing a proliferation of managers with the growth of the asset class?
We are really not seeing a growth in managers with the growth of the asset class. In the early days of CDOs with a robust credit market, management was more of a buy and hold approach. Now since the credit market downturn in the late 90s--active portfolio management to reduce and mitigate credit risk has proved most important. Investors have recognized the importance of active management, and are favoring more experienced management teams. As a result, it appears harder now for a start-up manager to come in and launch a CLO. To be successful, any new manager will need to have sufficient experience to make investors comfortable with relying on a new shop. But, saying that, investors also like to diversify the style of managers that they invest with.
LMW: What conditions has the market faced this year?
The market for CDOs has been the same as for other structured products. For the majority of this year, investors were focused on the Middle East and on digesting the credit market events from previous years. [Also] there has been some overhang in the market because of available CDO paper in the secondary market. The debt issuance market for CDOs is at historical highs, with investors and managers waiting on the sidelines to see more rational debt pricing.
LMW: What will the LSTA look at beyond consolidation?
The next stage will be market standardization, liquidity and transparency of the underlying assets. The LSTA wants to take a role similar to what it has done for the loan asset: increase interest in the asset class, standardization, documentation and disclosure in an effort to increase liquidity.