Los Angeles-based Special Value Investment Management, an affiliate of private investment firm Tennenbaum & Co., has closed an $885 million arbitrage collateralized debt obligation that includes what is believed to be the largest-ever equity tranche in a market-value CDO. The CDO, called Special Value Absolute Return 1, is composed of distressed securities including leveraged bank loans, high-yield bonds, equities and mezzanine pieces. The equity tranche is $300 million more than 30% of the vehicle. The average equity tranche for a CDO is 15%. "Our philosophy is to be cautious, and we don't want to be close to a default," said Michael Tennenbaum, former vice chairman of investment banking at Bear Stearns and founder of the investment firm, of the big equity cushion.
A rival portfolio manager that structures CDOs said Tennenbaum takes heavy positions in distressed debt and needs to have the larger equity position. Commenting on Tennenbaum's ability to raise the mammoth equity piece, the manager added, "He's a very smart guy who plays a lot in the distressed area."
Tennenbaum said three types of play make up the CDO: the bonds of out-of-favor large companies, such as in the power and cable industries; strategic equity, such as buying when stock is cheap to gain equity positions; and buying complicated debt investments. "This will take the form of loaning to companies when the banks are afraid, or funding an acquisition," he explained, adding that returns can be 15-30%.
Tennenbaum has been buying up assets over the past 18 months. "Market conditions are very attractive right now due to risk aversion from the banks and lenders," Tennenbaum said. "The bank and bond market is cautious in lending to complicated companies, and these are the ones we like."
The vehicle consists of a $430 million Aa2/AA tranche priced at 113 basis points over LIBOR. The remainder of the CDO is composed of A2/A, Baa2/BBB and Ba2/BB tranches. Morgan Stanley was the placement agent for the mezzanine notes of the CDO. Morgan and Tennenbaum placed the equity piece, while Commerzbank and CDC IXIS completed the senior tranche.