The AAA notes of Callidus Capital Management's first collateralized loan obligation will be wrapped by AMBAC Asset Assurance. The move is significant because insurers such as AMBAC, MBIA and Financial Security Assurance (FSA) have until recently put a freeze on wrapping CDO tranches and now appear to be dipping their toes back into the market. Ares Management also took a wrap from FSA on its latest deal, Ares VII CLO, which priced last month. "We are participating more selectively in the market," said Betsy Castenir, FSA's spokeswoman. She could not provide figures for activity and spokespeople at AMBAC and MBIA did not return calls. Officials at Callidus declined comment and Ares portfolio managers did not return calls. Wachovia Securities is preparing to price the notes for the Callidus deal next month.
After exiting the market last year, insurers such as FSA are returning to the market, said Stanislas Rouyer, a senior v.p. in Moody's Investors Service financial guarantors group. He noted that insurers had been extremely active in the last few years, but the timing was off. CDOs were a relatively new product with structural weaknesses, coinciding with one of the highest default levels of the last 30 years, he explained. Many of the structural issues have been addressed, Rouyer noted. But guarantors are now much more selective and are often participating only on super-senior AAA tranches for the highest quality deals, he said. "It's not as easy as pricing has strengthened," he added. "We are certainly seeing a re-emergence of the insurers, but they are doing it on their terms," a CDO underwriter stated.
One loan manager said a wrap can cost north of 20 basis points. But the underwriter said for large deals it is almost essential to get the wrap. For Callidus, the firm can sell to insurance companies looking for AAA paper to purchase into conduits, the manager said. "One investor can take up to $100 million of the paper," he noted. Another loan manager said as some of the traditional CDO buyers withdraw, it is becoming important to broaden the universe of potential investors. Ares is believed to be tapping money market funds--which are potentially a vast source of capital.
Here's how it works. Part of the AAA Ares notes (Class A-1a) are collateral for certificates that were issued to the money market accounts (together with the insurance wrap). The Class A-1a notes are held in a separate custodial account (together with the insurance policy) for the benefit of the certificate holders. What enables the money market buyers to purchase the paper is the fact that there is a liquidity facility that enables the issuer to take out the money market notes every year if the money market holders decide that they do not want to roll-over their paper. The arbitrage works because the cost of money market funds is about 50 basis points below what the AAA notes are yielding (LIBOR + 55 vs LIBOR +3-5 basis points). However, the cost of the insurance, the remarketing fee and the cost of the liquidity facility must be substracted.