Sheldon Sussman is in charge of Rabobank's capital markets business in the Americas and is also the global head of structuring for capital markets. His responsibilities include management of Rabobank's rated investment vehicles and asset management activities, including four asset backed commercial paper investment conduits, 11 collateralized debt obligations, and "Tango," a newly launched SIV.
BW: How is the arbitrage for structured finance CDOs?
SS: The arbitrage continues to be very strong but it is also very sector-specific. There are sectors where spreads are attractive enough and where the arbitrage works like residential mortgages or CDOs. Other types of collateral show spreads that are too tight to structure a CDO, like CMBS or REITs. For instance, take the triple-B tranche of an asset-backed securities CDO currently at 350-375 basis points over LIBOR, versus a 260 basis points spread a year ago: the arbitrage is there. On the other hand, take a triple-B tranche of a CMBS bond. It is at 130 basis points over swaps today, tighter than the 200 basis points over swaps level seen a year ago.
BW: How do you manage to balance the interests of both the debt and the equity? And is it a difficult balancing act to achieve as a collateral manager?
SS: You want to strike a balance and our deals are structured that way. For instance, in our multisector deals Solstice and Solstice II, we have during the re-investment period the equity return capped at a specific level. Any excess cash received above the capped return level is used to pay down the triple-B debt-holders. This devise, called a turbo feature, allows you to ensure that the debt holders have their fair opportunity to receive their desired return along with the equity holders. Equity holders are taking the greatest risk. Triple-A holders are taking the least risk. If there is deterioration of the underlying assets, the equity should bear that risk. Our structures are set up in such way that we can divert cash flow and ensure that it happens. We've been able to achieve stable equity returns while providing adequate protection for the debt. Nearly all of our vehicles have met and exceeded model market equity returns, which range from 16-22%. It all boils down to two things. First a choosy initial collateral selection. Second, the ability to be pro-active and have a significant par value build up strategy for the portfolio with active trading.
BW: Is there a strong RMBS bid for CDOs? And if yes, what impact does it have on spreads?
SS: Spreads have not come in because not all ABS CDO collateral managers are focused on RMBS collateral. Most firms buy very diversified pools and you have to be very specialized to have a high RMBS allocation in your collateral. We are working on a transaction that has a 60% RMBS bucket but many of the deals in the market do not have an allocation that exceeds 20%, simply because managers don't specialize in this asset class. Issuance has also been very high in the last quarter of last year and during this year's first quarter. So, even though demand has gotten up from CDO buyers, supply has also increased which is why there has been very little impact on spreads.
BW: How do you ramp up your assets for structured finance backed deals? Are tight ramp-up periods problematic for you?
SS: No, we don't find ramp-ups to be an impediment. Namely, we can elect to have Rabobank, our parent company, warehouse the collateral. We can also build into the structure of our deals, features that provide adequate ramp-up time to fill out the rest of the portfolio after closing. Some of these features may be revolving senior notes, for instance. Ramp-up time varies depending on the type of collateral in the pool and its availability in the market. In average, from the first bond purchase to the last one, there can be six to 12 months in any of our deals.
BW: What is the size of your CDO portfolio? Do you buy in the primary or secondary market and why?
SS: I cannot answer how big we are. I can tell you that we are one of the largest and most regular CDO investors in both mezzanine pieces and senior notes. We've been a consistent buyer for a number of years. And, we buy on both the primary and the secondary markets. When you buy on the secondary market, you know the portfolio and how it has been performing. It might be an advantage as you have a base on which to run your quantitative analysis. Buying on the primary market offers the reverse advantage: it's a brand new deal. It's clean.
BW: What are the weakest parts of your portfolio? Any particular exposure to manufactured housing, 12-b1 fees or aircraft?
SS: We always had small exposure to MH but typically to the higher tranches, single-A or double-A, which means several notches off the average rating of the overall portfolio. For 12-b1 fees we are very selective based on the type of servicer and also very vintage-sensitive. We also have aircraft exposure in a couple of deals but in buckets that do not exceed 1-2%.
BW: How are your CDO deals performing?
SS: All the ratings on the notes are still the same ratings as at the time of issuance. That is to say, none of our CDOs has been downgraded yet. Only one of our 11 CDO deals--Equinox--has had some of the debt tranches recently put on watch for downgrade by Moody's Investors Service. Yet, the equity return [on this deal] has been substantially high. On the other hand, we are only one of, I think three, collateral managers of multi-sector CDOs, that have had upgrades. Solstice was recently upgraded two notches by Fitch Ratings from triple-B to single-A minus.