Wachovia Securities has priced the notes for Guggenheim Investment Management's debut collateralized loan obligation, using a credit swap system rarely employed in cash-flow arbitrage deals. The $448 million deal, called 1888 Fund, uses a proprietary Wachovia structure called APEX, which protects the fund against par erosion due to defaults as well as distressed sales of credit-risk securities through the use of the APEX credit swap, stated Belinda Ghetti, a credit analyst with Standard & Poor's. Wachovia bankers and Todd Boehly, a portfolio manager at Guggenheim, declined comment, as the transaction had not closed as LMW went to press.
Market sources familiar with the structure explained it provides managers with flexibility, especially with proceeds from sales. This type of structure is not typically used as investors are often more comfortable with more conventional structures, explained another source. The CDO is differentiated from traditional CDOs as it includes three swaps entered into between Wachovia and the fund. Normally, if a CLO is forced to sell a credit at a loss, the fund will then try and re-invest the money, often buying discounted securities in order to pass over-collateralization tests. This can lead to lower credit quality. With APEX, a credit swap will provide the difference between the sale price on discounted and defaulted credits and the par value of those credits, effectively meeting the difference. The APEX credit swap will put in the amount of the losses on defaulted credits up to $47 million.
APEX also enables the fund to avoid selling defaulting credits. Instead, the fund can mark-to-market the default and fall back on the credit default swap. This allows the manager the flexibility to manage the workout process to maximize recovery values and provides enhancement to the senior tranches. Losses are reimbursed by the APEX swap counterparty, the source added.
One analyst suggested one drawback is the expense. The fee, which starts on the second payment date until the end of the reinvestment period, is 65 basis points per annum on $375 million. This includes the upfront and structuring fees. The protection, meanwhile, is for the A and B class notes. In order to prevent the junior tranches from carrying the burden, the BBB notes are guaranteed their coupon by Wachovia for the first five years, through an income swap that generates LIBOR and a balance swap that pays the rated spread.
Another potential downside is that the APEX credit swap is fully collateralized one for one with highly rated assets (AAA/A-1+), which may cause negative carry for the structure, suggested Ghetti.
The 1888 deal is the first offering from Guggenheim, run by a triumvirate of ex- J.H. Whitney & Co. loan pros (LMW, 9/2). The fund is approximately half filled and has seven months from closing to ramp up. The $365 million of AAA notes priced within current ranges at LIBOR plus 55 basis points, according to a banker. The AA tranche priced at LIBOR plus 160 basis points and the BBB priced at LIBOR plus 275 basis points. Equity is $17.5 million of the deal. Boehly, Steve Sautel and Adrian Duffy left J.H. Whitney at the start of this year, where they also managed bank loans. J.P. Morgan is the trustee.