Some managers are increasing the size of the structured note buckets in their collateralized debt obligations as they look to build par and diversify, and loan managers in particular have been seen buying credit-linked notes.
Because the CDO market is private, no figures for quantities could be ascertained. However, two Merrill Lynch Investment Management vehicles that comprise leveraged loans and high-yield bonds--Long Horn CDO and ML CBO SERIES 1997 Royalton 1--have seen 4% and 5.7% increases, respectively, in their structured note buckets, according to a Merrill Lynch report. Most CDO managers have structured note buckets comprising 10-20% of their vehicles.
"The primary reasons [for the purchasing of credit-linked notes] are that CDO managers can purchase a high-yielding, well-performing credit with a maturity date before the CDO's maturity date," said Dan Castro, a managing director at Merrill. "In addition, these transactions can often be structured to have a discount price, which helps the manager to build par. Often, this can be more advantageous than purchasing deeply discounted, poorly performing collateral."
Credit-linked notes can be bought for three years, for example, and some of the older vehicles need collateral to fit this time frame, another analyst explained, noting that bonds and loans typically have longer maturities. "You can get the same spread as loan paper but a higher-rated borrower," the analyst added.