The rush returns to ABS

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From an asset class perspective, the CDO sector dominates the pipeline and within that sector CLO issuance is at the vanguard.

The last months of 2004 were notable for the lack of a traditional end-of-year rush to print structured finance trades. But this year the rush is back, with ABS syndicate bankers expected to work right up to the Christmas break to complete the backlog of deals.

To some extent, CLOs have been overshadowed this year by continued product innovation in the synthetic CDO space, with the introduction of various structures such as leveraged super seniors and credit principal protected notes.

“The CDO space is highly innovative in the way it adapts to market trends and investor appetite,” says Ganesh Rajendra, head of European securitization research at Deutsche Bank.

The flexibility of synthetic structures is one of its key strengths, allowing arrangers to build in greater yield or risk as the buy-side desires. However, these bespoke deals account for only a paltry 11% of European CDO issuance: managed cash CDOs are responsible for just under 40%; while half of CDO supply is of the traditional cash bank balance sheet kind. The appearance in November by Barclays (Gracechurch Corp Loans) and HSBC (Metrix Funding) with two massive notable balance sheet CLOs, sized at £5 billion and £2 billion respectively, was merely a coincidence rather than signifying a trend.

“Overall, CDO volume year-to-date is up 28% on the comparable period last year, fuelled mostly by growth in SME and leveraged loan CLO issuance,” says Rajendra.

A month before the market’s traditional year-end, 12 cash CLOs were expected to price, perhaps leading to investor indigestion over the €12 billion of supply.

Leveraged loans

There is little doubt about the underlying cause for this activity: burgeoning leveraged loans. Issuance so far this year is an amazing $264 billion, compared with $160.5 billion in the same period of 2004. The scale, scope and aggression of leveraged buy-outs has been one of the main trends for the past 18 months at least.

In addition to record issuance of senior secured leveraged loans there has also been a significant uptick in mezzanine and PIK notes, which have been used to add diversity and yield to CLO portfolios.

Major concerns have been voiced in the CLO investment community that managers will not be able to be so choosy when ramping up their new deals.

One of the most interesting CLOs to be mandated in recent weeks was for hedge fund manager Cheyne Capital, which is very experienced in mezz, second lien and workout situations. Most managed cash CLOs are around €500 million or less in size, but Cheyne is planning a €1 billion sized deal via Nomura. The deal’s structure has flexibility built in, with a very long ramp up period of two years, allowing the manager to be highly selective on credits. It is not likely to print until the last week before the market shuts down.