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CDO Issuers Awaken Market-Value Sector
Asset Backed Alert, Harrison Scott Publications Inc. (October 1, 2004)

Collateralized debt obligations supported by actively traded pools of assets are making a comeback.

A growing number of CDO issuers are working on - or at least thinking about - floating so-called market-value transactions over the next few months. Such deals, which once ruled the CDO arena, had largely vanished for several years as nervous investors flocked to more-stable cashflow issues.

Now asset managers are interested in following the lead of GoldenTree Asset Management of New York, Sankaty Advisors of Boston and Tennenbaum Capital Partners of Santa Monica, Calif. - all of which recently completed market-value deals. Deutsche Bank ran the books on Sankaty's and GoldenTree's most recent issues, while CDC IXIS was the underwriter of Tennenbaum's transaction. Word has it that both banks, as well as Morgan Stanley, are working on similar offerings from other shops.

"It's not the drought that we had been experiencing," said Gary Witt, a managing director in Moody's CDO group.

Managers of market-value deals usually mark their collateral to market on a daily or weekly basis. That's because they constantly buy and sell assets as they strive to generate the largest possible returns and maintain liquidity. Their CDOs can contain an array of rated and unrated collateral, including corporate bonds and loans, distressed debt, government securities, structured products, commercial paper, credit-default swaps and even equities.

Such deals lost their luster in the late 1990s, as mounting losses, fluctuating bond prices and spotty liquidity within the collateral pools scared off investors. Still, proponents of market-value transactions point out that their deals performed better than cashflow CDOs backed by unsecured corporate bonds. But investors have snubbed those issues over the years as well, gravitating instead to bonds backed by less-risky assets.

Most of the deals that caught their attention were cashflow CDOs, which are generally buy-and-hold vehicles that seek to minimize the risk of defaults among their collateral. The managers of such transactions usually restrict their investments to less varied pools of higher-quality assets.

Among those issues are deals collateralized by asset- and mortgage-backed securities, which now account for the majority of CDO collateral. Unfortunately for CDO issuers, soaring demand for securitized issues has pushed down returns on such investments. Hence, the resurgent appeal of market-value deals, which allow issuers to tap a broader spectrum of assets with fatter arbitrage opportunities. "There's not much visible out there yet, but we do know of a lot of managers who are talking about it," said one CDO researcher at a Wall Street bank.

Today's market-value CDOs often bear little resemblance to their 20th-century counterparts. For instance, the deals from GoldenTree and Sankaty don't invest in private equity instruments, which were once common as CDO collateral. Private equity holdings fell out of favor with many CDO investors because they couldn't figure out how much the assets were worth.

The main obstacle now facing market-value transactions is that most CDO buyers are used to evaluating deals based on the credit quality of their underlying assets.

Market-value CDOs "will get a push-back from investors who may not be comfortable with . . . shifting from a probability-of-default analysis to a market-value analysis," the researcher said.



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