CDOs are back!

[Olmsted]

So the new-issue CDO market is alive again, they're just not calling them 'CDOs' any more:

 

http://www.bloomberg.com/news/2013-01-14/wall-street-returns-to-property-cdos-in-yield-hunt.html

 

plus ça change...

 

[mikazo]

And this too...

 

http://www.businessweek.com/news/2013-01-13/hedge-fund-leverage-rises-to-most-since-2004-in-new-year

 

We know how this played out last time...

[jay21]

A lot of these new deals are supposed to be less levered.  Still I think these are horrible investments.  They are almost structured to fail imo.

[GrizzlyRock]

CLOs proved themselves in the downturn providing risk solid returns.  Great business model too but very hard to get into

 

No opinion on other C"insert letter"O structures.

[HJ]

CLOs proved themselves in the downturn providing risk solid returns.  Great business model too but very hard to get into

 

No opinion on other C"insert letter"O structures.

 

Actually not that hard if you can put up the equity.  Even if you don't have infrastructure, you can put together some sort of partnership with a second tier guy who does, and haven't done a deal in CLO2.0 yet.  Let me know if anyone want to explore.  Environment has certainly changed since QE3.  Don't think CLO equity will do as well as they did in this cycle just past, but they should still be fair.

 

For those who may not be that familiar, the CLO equity that were done at the peak of the cycle 2006-2007 are turning out to be among the best credit instruments ever created, for reasons that are quite obvious in hindsight.

[Kraven]

CLOs proved themselves in the downturn providing risk solid returns.  Great business model too but very hard to get into

 

No opinion on other C"insert letter"O structures.

 

Actually not that hard if you can put up the equity.  Even if you don't have infrastructure, you can put together some sort of partnership with a second tier guy who does, and haven't done a deal in CLO2.0 yet.  Let me know if anyone want to explore.  Environment has certainly changed since QE3.  Don't think CLO equity will do as well as they did in this cycle just past, but they should still be fair.

 

For those who may not be that familiar, the CLO equity that were done at the peak of the cycle 2006-2007 are turning out to be among the best credit instruments ever created, for reasons that are quite obvious in hindsight.

 

I assume GrizzlyRock is talking about being a manager. Without the equity (pay to play) its almost impossible to get started now. Even with the equity could be tough getting the market approval without a long enough history managing a hefty loan book. The days of "2 guys and a Bloomberg" getting a deal are long gone. Agreed on CLO equity. Turned out well.

[GrizzlyRock]

Kraven - Correct.

[HJ]

 

I assume GrizzlyRock is talking about being a manager. Without the equity (pay to play) its almost impossible to get started now. Even with the equity could be tough getting the market approval without a long enough history managing a hefty loan book. The days of "2 guys and a Bloomberg" getting a deal are long gone. Agreed on CLO equity. Turned out well.

 

Not quite 2 guys and a Bloomberg, but I'm seeing something not that far from that getting done.  It was never that easy to do that kind of deal, even in the hay days.  But clearly today's CLO new issuance market is not constrained by availability of debt capital.  I haven't tallied statistics, but there have been a fair amount of first time issuers done this year, albeit mostly by reputable institutions, but there are a couple that at least in my eyes are not that far from 2 guys and a Bloomberg.

[Kraven]

 

I assume GrizzlyRock is talking about being a manager. Without the equity (pay to play) its almost impossible to get started now. Even with the equity could be tough getting the market approval without a long enough history managing a hefty loan book. The days of "2 guys and a Bloomberg" getting a deal are long gone. Agreed on CLO equity. Turned out well.

 

Not quite 2 guys and a Bloomberg, but I'm seeing something not that far from that getting done.  It was never that easy to do that kind of deal, even in the hay days.  But clearly today's CLO new issuance market is not constrained by availability of debt capital.  I haven't tallied statistics, but there have been a fair amount of first time issuers done this year, albeit mostly by reputable institutions, but there are a couple that at least in my eyes are not that far from 2 guys and a Bloomberg.

 

I'm not close enough to it to know anymore the current state of play on a granular level. I do find it surprising that loan deals are getting done like that though. Interesting that they are. Many many years ago I saw numerous deals that were literally 2-3 guys and a Bloomberg. There was an African debt deal done that was a couple guys in a house in the burbs. Times change.

[LC]

Can anyone point towards a primer on the history of CLOs you guys are referring to? I don't know much about this market but it sounds...entertaining :)

[Kraven]

Can anyone point towards a primer on the history of CLOs you guys are referring to? I don't know much about this market but it sounds...entertaining :)

 

I don't know of any real history of CLOs. Not exactly what youre looking for but The Big Short by Michael Lewis has a good description of CDOs and some history. It's not all accurate but close enough.

[HJ]

Can anyone point towards a primer on the history of CLOs you guys are referring to? I don't know much about this market but it sounds...entertaining :)

 

Don't know if there's a place to point you to, but the gist of it is that CLO's are backed by leveraged loans (think Realogy, First Data, TXU, Delphi) and were funded with securitized debt, the key being those were term funded, actually overfunded term wise because of a "Reinvestment Option", without mark to market trigger.  In the crisis, 1) bank loans didn't crash out, instead, were repriced to very high spreads.  2) CLO's weren't forced to sell credits that all the credit hedge funds were forced to sell because of margin calls.  On the margin they actually bought into the abyss.  At 12x leverage, when assets all of a sudden yield 300 bps more than you originally planned, but liabilities didn't change in spread, equity is now yielding in excess of 30%.  Guys are now trying to do it again, and it's one of the few securitization market that still functions today, and is benefitting from QE3.  There's literally no risk free bonds to buy, so you buy this.

 

[jay21]

Can anyone point towards a primer on the history of CLOs you guys are referring to? I don't know much about this market but it sounds...entertaining :)

 

Don't know if there's a place to point you to, but the gist of it is that CLO's are backed by leveraged loans (think Realogy, First Data, TXU, Delphi) and were funded with securitized debt, the key being those were term funded, actually overfunded term wise because of a "Reinvestment Option", without mark to market trigger.  In the crisis, 1) bank loans didn't crash out, instead, were repriced to very high spreads.  2) CLO's weren't forced to sell credits that all the credit hedge funds were forced to sell because of margin calls.  On the margin they actually bought into the abyss.  At 12x leverage, when assets all of a sudden yield 300 bps more than you originally planned, but liabilities didn't change in spread, equity is now yielding in excess of 30%.  Guys are now trying to do it again, and it's one of the few securitization market that still functions today, and is benefitting from QE3.  There's literally no risk free bonds to buy, so you buy this.

 

Do you really see equity yielding 30% now?  I thought a lot of people moved their hurdles back down to 15%.

 

I'm closer to the RMBS world than CLO world and I am seeing much more reasonable yields there.

[HJ]

 

Do you really see equity yielding 30% now?  I thought a lot of people moved their hurdles back down to 15%.

 

I'm closer to the RMBS world than CLO world and I am seeing much more reasonable yields there.

 

I'm describing legacy CLO's done at the top of the market in '06-'07, with the tightest collateral, but also tightest liability spreads, AAA locked at L + 25, equity at time of issuance was projected to have IRR in the low teens, but are now yielding 30% (after incentive fee to the manager).  New issue CLO's today would come out at low teens (loss adjusted), right on top of new issue whole loan RMBS deals, validating Warrent Buffet's statement in that famous fortune article: the cost of equity across time, across industry, has basically been 15% pretax.

 

Couple of things about CLO very different from an RMBS securitization:  CLO's have a 5 year +/-  reinvestment period, which provides optionality that doesn't exist with RMBS deals.  A properly managed CLO tend to hold defaulted assets until ultimate recovery, which in many cases could be above 100% of original par value.  Such dynamics doesn't exist in RMBS, when servicer just kick the foreclosed property to say Ocwen, who goes on to rehabilitates the property, and get the upside on the other side.  RMBS buyers just took the loss. 

 

If you listen to Michael Milken, he'd tell you corporate credit is better than consumer credit, which in turn, is better than sovereigns.  The first statement makes some intuitive sense to me.  If a company fires 10% of its workforce, consumer credit at large of the economy would be affected, but the company would still most likely pay back its debt, or at least try very hard to do so.  Bank loans, in turn, is arguably the best structured corporate credit.  All of this help explain the performance of CLO equities in the last cycle, but none more so than the principal of getting funded with non-recourse debt with no mark to market leverage.

[jay21]

 

Do you really see equity yielding 30% now?  I thought a lot of people moved their hurdles back down to 15%.

 

I'm closer to the RMBS world than CLO world and I am seeing much more reasonable yields there.

 

I'm describing legacy CLO's done at the top of the market in '06-'07, with the tightest collateral, but also tightest liability spreads, AAA locked at L + 25, equity at time of issuance was projected to have IRR in the low teens, but are now yielding 30% (after incentive fee to the manager).  New issue CLO's today would come out at low teens (loss adjusted), right on top of new issue whole loan RMBS deals, validating Warrent Buffet's statement in that famous fortune article: the cost of equity across time, across industry, has basically been 15% pretax.

 

Couple of things about CLO very different from an RMBS securitization:  CLO's have a 5 year +/-  reinvestment period, which provides optionality that doesn't exist with RMBS deals.  A properly managed CLO tend to hold defaulted assets until ultimate recovery, which in many cases could be above 100% of original par value.  Such dynamics doesn't exist in RMBS, when servicer just kick the foreclosed property to say Ocwen, who goes on to rehabilitates the property, and get the upside on the other side.  RMBS buyers just took the loss. 

 

If you listen to Michael Milken, he'd tell you corporate credit is better than consumer credit, which in turn, is better than sovereigns.  The first statement makes some intuitive sense to me.  If a company fires 10% of its workforce, consumer credit at large of the economy would be affected, but the company would still most likely pay back its debt, or at least try very hard to do so.  Bank loans, in turn, is arguably the best structured corporate credit.  All of this help explain the performance of CLO equities in the last cycle, but none more so than the principal of getting funded with non-recourse debt with no mark to market leverage.

 

Maybe I should learn CLOs a little better but a thought a big problem with them was that spreads got extremely wide and caused OC to collapse.  So then triggers were hit and they had to starting paying down principal.  Basically selling when things were cheapest.  I know the A tranches didn't get touched, but I thought that the mezz and equity got hurt pretty badly.  Did this not happen?  If spreads stayed very wide for a year or two more, would this have happened?

[onyx1]

 

Do you really see equity yielding 30% now?  I thought a lot of people moved their hurdles back down to 15%.

 

I'm closer to the RMBS world than CLO world and I am seeing much more reasonable yields there.

 

I'm describing legacy CLO's done at the top of the market in '06-'07, with the tightest collateral, but also tightest liability spreads, AAA locked at L + 25, equity at time of issuance was projected to have IRR in the low teens, but are now yielding 30% (after incentive fee to the manager).  New issue CLO's today would come out at low teens (loss adjusted), right on top of new issue whole loan RMBS deals, validating Warrent Buffet's statement in that famous fortune article: the cost of equity across time, across industry, has basically been 15% pretax.

 

Couple of things about CLO very different from an RMBS securitization:  CLO's have a 5 year +/-  reinvestment period, which provides optionality that doesn't exist with RMBS deals.  A properly managed CLO tend to hold defaulted assets until ultimate recovery, which in many cases could be above 100% of original par value.  Such dynamics doesn't exist in RMBS, when servicer just kick the foreclosed property to say Ocwen, who goes on to rehabilitates the property, and get the upside on the other side.  RMBS buyers just took the loss. 

 

If you listen to Michael Milken, he'd tell you corporate credit is better than consumer credit, which in turn, is better than sovereigns.  The first statement makes some intuitive sense to me.  If a company fires 10% of its workforce, consumer credit at large of the economy would be affected, but the company would still most likely pay back its debt, or at least try very hard to do so.  Bank loans, in turn, is arguably the best structured corporate credit.  All of this help explain the performance of CLO equities in the last cycle, but none more so than the principal of getting funded with non-recourse debt with no mark to market leverage.

 

Maybe I should learn CLOs a little better but a thought a big problem with them was that spreads got extremely wide and caused OC to collapse.  So then triggers were hit and they had to starting paying down principal.  Basically selling when things were cheapest.  I know the A tranches didn't get touched, but I thought that the mezz and equity got hurt pretty badly.  Did this not happen?  If spreads stayed very wide for a year or two more, would this have happened?

 

Spread widening and resultant changes in market value have no effect on OC levels in CLO structures.  Same for CDOs, CMOs etc.  There is no forced selling of assets due to a drop in market value.

[Kraven]

 

Do you really see equity yielding 30% now?  I thought a lot of people moved their hurdles back down to 15%.

 

I'm closer to the RMBS world than CLO world and I am seeing much more reasonable yields there.

 

I'm describing legacy CLO's done at the top of the market in '06-'07, with the tightest collateral, but also tightest liability spreads, AAA locked at L + 25, equity at time of issuance was projected to have IRR in the low teens, but are now yielding 30% (after incentive fee to the manager).  New issue CLO's today would come out at low teens (loss adjusted), right on top of new issue whole loan RMBS deals, validating Warrent Buffet's statement in that famous fortune article: the cost of equity across time, across industry, has basically been 15% pretax.

 

Couple of things about CLO very different from an RMBS securitization:  CLO's have a 5 year +/-  reinvestment period, which provides optionality that doesn't exist with RMBS deals.  A properly managed CLO tend to hold defaulted assets until ultimate recovery, which in many cases could be above 100% of original par value.  Such dynamics doesn't exist in RMBS, when servicer just kick the foreclosed property to say Ocwen, who goes on to rehabilitates the property, and get the upside on the other side.  RMBS buyers just took the loss. 

 

If you listen to Michael Milken, he'd tell you corporate credit is better than consumer credit, which in turn, is better than sovereigns.  The first statement makes some intuitive sense to me.  If a company fires 10% of its workforce, consumer credit at large of the economy would be affected, but the company would still most likely pay back its debt, or at least try very hard to do so.  Bank loans, in turn, is arguably the best structured corporate credit.  All of this help explain the performance of CLO equities in the last cycle, but none more so than the principal of getting funded with non-recourse debt with no mark to market leverage.

 

Maybe I should learn CLOs a little better but a thought a big problem with them was that spreads got extremely wide and caused OC to collapse.  So then triggers were hit and they had to starting paying down principal.  Basically selling when things were cheapest.  I know the A tranches didn't get touched, but I thought that the mezz and equity got hurt pretty badly.  Did this not happen?  If spreads stayed very wide for a year or two more, would this have happened?

 

Spread widening and resultant changes in market value have no effect on OC levels in CLO structures.  Same for CDOs, CMOs etc.  There is no forced selling of assets due to a drop in market value.

 

One caveat - there is forced selling in market value deals (as opposed to the much more popular cash flow deals), but those were much more limited and that's not what the poster was referring to anyway.

[onyx1]

 

Do you really see equity yielding 30% now?  I thought a lot of people moved their hurdles back down to 15%.

 

I'm closer to the RMBS world than CLO world and I am seeing much more reasonable yields there.

 

I'm describing legacy CLO's done at the top of the market in '06-'07, with the tightest collateral, but also tightest liability spreads, AAA locked at L + 25, equity at time of issuance was projected to have IRR in the low teens, but are now yielding 30% (after incentive fee to the manager).  New issue CLO's today would come out at low teens (loss adjusted), right on top of new issue whole loan RMBS deals, validating Warrent Buffet's statement in that famous fortune article: the cost of equity across time, across industry, has basically been 15% pretax.

 

Couple of things about CLO very different from an RMBS securitization:  CLO's have a 5 year +/-  reinvestment period, which provides optionality that doesn't exist with RMBS deals.  A properly managed CLO tend to hold defaulted assets until ultimate recovery, which in many cases could be above 100% of original par value.  Such dynamics doesn't exist in RMBS, when servicer just kick the foreclosed property to say Ocwen, who goes on to rehabilitates the property, and get the upside on the other side.  RMBS buyers just took the loss. 

 

If you listen to Michael Milken, he'd tell you corporate credit is better than consumer credit, which in turn, is better than sovereigns.  The first statement makes some intuitive sense to me.  If a company fires 10% of its workforce, consumer credit at large of the economy would be affected, but the company would still most likely pay back its debt, or at least try very hard to do so.  Bank loans, in turn, is arguably the best structured corporate credit.  All of this help explain the performance of CLO equities in the last cycle, but none more so than the principal of getting funded with non-recourse debt with no mark to market leverage.

 

Maybe I should learn CLOs a little better but a thought a big problem with them was that spreads got extremely wide and caused OC to collapse.  So then triggers were hit and they had to starting paying down principal.  Basically selling when things were cheapest.  I know the A tranches didn't get touched, but I thought that the mezz and equity got hurt pretty badly.  Did this not happen?  If spreads stayed very wide for a year or two more, would this have happened?

 

Spread widening and resultant changes in market value have no effect on OC levels in CLO structures.  Same for CDOs, CMOs etc.  There is no forced selling of assets due to a drop in market value.

 

One caveat - there is forced selling in market value deals (as opposed to the much more popular arbitrage deals), but those were much more limited and that's not what the poster was referring to anyway.

 

Yes.  And the potential of forced selling is exactly why they are so extremely rare.

[HJ]

There were 2 classes of CLO's, "Market Value" deals, where they were funded with total return swaps, and had to unwind when  market value was hit, ala credit hedge funds, and "Cash Flow' deals, which was 90% of the CLO market.  O/C triggers were hit, but for very nuanced reasons.  There were some defaults, but more downgrades into CCC or below.  The O/C triggers were structured to take a hit for those downgrades.  Equity were shut off for a period of time, so were some of the mezzanine bonds.  Cash was used to pay down AAA bonds.  but after a year or so of this, together with the corporate credit healing, PE shops worked very hard to restructure the balance sheet of their businesses, the issuers were upgraded, and the structured healed itself.  Further, bank loans were structured with re-pricing options and all sorts of covenants, and whenever equity wants to do something to the capital structure of the company, bank loans gets a consent fee and re prices their loans to the market spread.

 

Old war stories, but at the bottom, mezzanine CLO bonds was priced assuming they would just collect a couple of more years of coupon and then go to zero.  At L + 150 or a bit higher, they were trading for 5-10 cents on the dollar.  As for the equities, their price fell so fast, most didn't even get a chance to trade before they were marked to zero, and therefore no more reason to trade.  The same bonds are priced in the 80's - 90's today, equities above par.  10 baggers within 2 years.  Those were arguably THE fulcrum security for the fixed income market 2009-2010. 

 

     

 

Do you really see equity yielding 30% now?  I thought a lot of people moved their hurdles back down to 15%.

 

I'm closer to the RMBS world than CLO world and I am seeing much more reasonable yields there.

 

I'm describing legacy CLO's done at the top of the market in '06-'07, with the tightest collateral, but also tightest liability spreads, AAA locked at L + 25, equity at time of issuance was projected to have IRR in the low teens, but are now yielding 30% (after incentive fee to the manager).  New issue CLO's today would come out at low teens (loss adjusted), right on top of new issue whole loan RMBS deals, validating Warrent Buffet's statement in that famous fortune article: the cost of equity across time, across industry, has basically been 15% pretax.

 

Couple of things about CLO very different from an RMBS securitization:  CLO's have a 5 year +/-  reinvestment period, which provides optionality that doesn't exist with RMBS deals.  A properly managed CLO tend to hold defaulted assets until ultimate recovery, which in many cases could be above 100% of original par value.  Such dynamics doesn't exist in RMBS, when servicer just kick the foreclosed property to say Ocwen, who goes on to rehabilitates the property, and get the upside on the other side.  RMBS buyers just took the loss. 

 

If you listen to Michael Milken, he'd tell you corporate credit is better than consumer credit, which in turn, is better than sovereigns.  The first statement makes some intuitive sense to me.  If a company fires 10% of its workforce, consumer credit at large of the economy would be affected, but the company would still most likely pay back its debt, or at least try very hard to do so.  Bank loans, in turn, is arguably the best structured corporate credit.  All of this help explain the performance of CLO equities in the last cycle, but none more so than the principal of getting funded with non-recourse debt with no mark to market leverage.

 

Maybe I should learn CLOs a little better but a thought a big problem with them was that spreads got extremely wide and caused OC to collapse.  So then triggers were hit and they had to starting paying down principal.  Basically selling when things were cheapest.  I know the A tranches didn't get touched, but I thought that the mezz and equity got hurt pretty badly.  Did this not happen?  If spreads stayed very wide for a year or two more, would this have happened?

[onyx1]

 

Old war stories, but at the bottom, mezzanine CLO bonds was priced assuming they would just collect a couple of more years of coupon and then go to zero.  At L + 150 or a bit higher, they were trading for 5-10 cents on the dollar.  As for the equities, their price fell so fast, most didn't even get a chance to trade before they were marked to zero, and therefore no more reason to trade.  The same bonds are priced in the 80's - 90's today, equities above par.  10 baggers within 2 years.  Those were arguably THE fulcrum security for the fixed income market 2009-2010. 

 

True that.  The nature of structures can cause violent price movements.  During the corporate fraud/telecom meltdown in 2003, I took over a CDO mezz position at 4 cents on the dollar.  I asked another trader if he cared to buy it and he told me his bid was ZERO.  Enter market recovery, and 18 months later it matured at PAR, a 25-bagger.  I remind my friend of his bid as often as I can, hahaha!

[Olmsted]

True that.  The nature of structures can cause violent price movements.  During the corporate fraud/telecom meltdown in 2003, I took over a CDO mezz position at 4 cents on the dollar.  I asked another trader if he cared to buy it and he told me his bid was ZERO.  Enter market recovery, and 18 months later it matured at PAR, a 25-bagger.  I remind my friend of his bid as often as I can, hahaha!

 

25-bagger wasn't enough, I guess he was just holding out for the infinity-bagger.  That's buy discipline there.  ;)