Global Best CDO house: Merrill Lynch

How Stan O’Neal transformed Merrill Lynch

Also shortlisted in this category:
Deutsche Bank
JPMorgan

Any winner of a global CDO award has to be able to demonstrate a breadth of product and clear examples of innovation and size. This year’s winner, Merrill Lynch, ticks the boxes on all three, having achieved impressive growth and innovation in its CDO business in the past year.

The CDO market, which in funded, league table terms alone is now a $1 trillion dollar market, is dominated by the US. Merrill was ranked number one for the calendar year 2005 with $25 billion volume and a 16.2% market share. The business can be broadly divided into high-grade ABS CDOs (a sector that Merrill dominates with a 34% market share), trust preferreds (in which it has a more than 50% market share), CLOs and synthetics. The latter two had been considered a weakness of Merrill’s platform, but the bank has made impressive progress in addressing them this year. For example, Merrill was ranked a lowly 13 in the CLO league tables to the third quarter of 2004, but had risen to number six for the equivalent period in 2005, largely by concentrating on the middle market space. It still, however, has a long way to go to catch up with Citigroup and Bear Stearns in this asset class.

Harin De Silva and Ken Margolis (r), Merrill Lynch: looking for good, cheap technical trades

On the synthetic front, Merrill is among the largest traders of ABS CDS and was instrumental in the development of that market this year. And in a year in which several players were hit with significant correlation trading losses, Merrill increased revenue from its synthetic business by more than 100%. The bank did its first managed synthetic CDO squared and its first leveraged super-senior deal and changed the way that it does cash ABS CDOs to make them all cash/synthetic hybrid structures.

Merrill was at the forefront of finding the macro funds that have driven so much of the volume in junior home equity loan ABS CDS and has been a beneficiary of spread movement in that part of the market. “A lot of people got scared and started liquidating their warehouses but we were confident that liabilities wouldn’t gap out,” says Harin De Silva, co-head of the global CDO business at Merrill Lynch. “As a consequence we had a windfall in early January.”

Key deals in the mezzanine ABS CDO market this year included TCW South Coast VII, which was the largest ever funded mezzanine ABS CDO. It was an early example of a structure enabling shorting of credit, and saw $1.17 billion issuance in the midst of a difficult collateral spread tightening environment. Another significant mezz transaction was the Khaleej II deal. This , backed by ABS CDS, was one of the first to use PAUG technology and demonstrates the firm’s efforts to provide liquidity to the ABS CDS market.

But it is in the trust preferred (Trups) asset class that Merrill has really left its mark this year. “The Trups structure is attractive to smaller unrated companies without good access to the capital markets as it is more economic to pool assets through a CDO,” says Kenneth Margolis, co-head with De Silva of the global CDO business. “We look for cheap assets that are good assets but trade cheaply for technical reasons.” The technique was exported to Europe in 2005 via the Dekania Europe CDO, arranged by Merrill Lynch and Cohen Brothers subsidiary Dekania Capital Management. That deal pooled subordinated debt from European insurance companies.

The $2.5 billion Taberna series of transactions introduced a new and efficient form of capital to the real estate investment trust industry in the form of the first ever Reit Trups deals. According to Daniel Cohen, founder of investment firm Cohen Brothers: “The Taberna deals have really changed the nature of Reit financing in the US… the CDO form of risk management has made capital more accessible and more useful for middle market borrowers in the Reit space.”

Although Merrill has nowhere near the market size in Europe and Asia that it has in the US, it wrote €2.25 billion of business in Europe, working with Mizuho, AXA IM and Prudential M&G in addition to Dekania. In Australia, Merrill brought the first US high-grade CDO to be managed by an Australian issuer (BNB Capital Markets) via Bernoulli High Grade CDO.

Much of Merrill’s success in the CDO space in 2005 can be attributed to ex-managing director and head of global structured credit products Chris Ricciardi, who left the bank in February this year to join Cohen Brothers. It will be interesting to see how the pace of growth and innovation is sustained in the years to come.

How Stan O’Neal transformed Merrill Lynch

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Global Best CDO house: Merrill Lynch

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