Collateralized debt obligation equity investors are demanding principal-protected securities against credit risk. Arturo Cifuentes, managing director at CDO collateral manager Triton Partners, says principal protected securities are "an old trick" that has reappeared in more and more deals over the past few months. However, with U.S. Treasury bonds trading at high dollar prices, protection has a high cost attached to it, says a CDO analyst with a leading underwriter.
The "old trick" is a technique wherein a CDO equity investor will purchase a security consisting of CDO equity and a five- to 10-year zero coupon Treasury bond. At maturity, the investor will recoup principal plus the upside, if there is any, on the equity piece. Jeffrey Stern, a securitization attorney with Thacher Proffitt & Wood, says another factor explaining the trend may be regulatory. He says principal-protected securities allow investors barred from investing in non-rated securities--typically insurance companies in the U.S. or European investors-- to tap into this potentially highly rewarding market, as principal-protected securities are rated, usually double-B.