A 500-700 million structure backed entirely by mezzanine loans is being touted as an innovative cross between a collateralized debt obligation and a leveraged fund. The deal taking shape in Europe is unique in that its leverage is less than in a traditional CDO, but higher than a straight fund, sources told BondWeek, an LMW sister publication. The vehicle, AIG Mezzvest Funding, is scheduled to hit the European market in the next few weeks, according to syndicate officials in London. It has not been decided if the product will be pitched as a typical cash flow arbitrage CDO or a leveraged fund. The collateral manager is AIG Mezzvest, in London.
One credit derivative official in London says no European CDOs has ever been backed at a 100% by mezzanine loans before. A European analyst with a rating agency says the reason is simple: the CDO market in Europe is at its infancy stage and the mezzanine market is not a large, developed market. Asked about why a structure would be built around a non-diversified pool of assets, made exclusively of mezzanine loans, the same analyst invokes two potential factors. The first one lies in the fact that European managers tend to over-specialize. "A mezz loan manager is a pro at managing mezz loans and has probably no valuable experience in managing any other asset class," says this analyst. A second factor could be that combining different asset classes when structuring a CDO makes the product harder to sell. "With one asset class in the collateral, you may have an easier story to tell and sometimes, those deals sell very well," says the analyst. In the U.S., only a few of those entirely mezzanine loans CDOs have been issued according to Fitch.
Going downward in seniority, mezzanine loans are the intermediate class of assets between senior debt and equity. They are senior to high-yield bonds, which means that recovery rates are higher. One credit derivative official says that even though European mezzanine loans are senior, they offer a higher yield because of their illiquidity, creating a higher arbitrage potential.
The other main characteristic of this new product is its hybrid nature between a CDO and a levered fund, as reflected by its name. One sellsider says, "The new structure is very innovative. It has never been done before. It is not a standard CDO, but merely a cross over between a CDO and a levered fund." The level of leverage in AIG Mezzvest Funding has yet to be decided, according to a City official, but it will be less than 85%.
Merrill Lynch is co-lead manager on the equity side and CIBC World Markets will be co-lead on the debt side, according to a structured finance market player. The new debt will be globally distributed and available to U.S. investors. The sale is expected to close in several months. The notes are rated by Fitch and Moody's Investors Service. Calls to Merrill Lynch and CIBC were not returned.