In response to increasing investor demand for collateralized debt obligations (CDOs), Barclays Capital is making a concerted effort to build its presence in that market. Under the umbrella of its fund management arm, Barclays Capital Asset Management (BCAM), the company has already launched one CDO and has two more in the pipeline.
"This reflects from an effort by Barclays Capital to build up its third party asset management business," said Elliot Asarnow, global head of research and credit portfolio at Barclays. "Given our strengths and capabilities in the credit markets and structured products areas, the CDO was the obvious way to raise funds under the asset management arm," he said.
The driving force behind the move to structure CDOs comes from two of Barclays' groups, which are active in the non-investment grade sector. The first CDO, called Blue Eagle, was launched last December as a result of the London-based high yield investment group, managed by David Forbes Nixon. This was a EURO450 million vehicle consisting mostly of high yield bonds, combined with a small amount of loans and synthetics.
The London team is also behind the next offering, a European loan-oriented CDO, due for launch in the final quarter of 2001. Stateside, the U.S. leveraged loan group will launch the third transaction sometime in the first two quarters of next year. That vehicle will invest primarily in leveraged loans and bonds, Asarnow said.
Loans Favored Over Bonds
in CDO Make-Up
Barclay's pending CDOs consist more of loans than high yield bonds. This was the case for the Blue Eagle transaction, too, and there are a number of reasons for it. Firstly, there has been a substantial growth in the number of institutional investors entering the European loan market, Asarnow said.
In the second place, the deterioration of the European high yield market over the course of this year has enhanced the appeal of loans.
"The move towards loans is a reflection of the recent volatility in the high yield bond market - it is timely to be focusing on a loan-based transaction now," Asarnow said.
Most market participants seem to agree that a CDO with a blended mix of bonds and loans, as opposed to one made up of just bonds, has a better overall recovery rate and can achieve a better credit status from the agencies.
"The CLO/CDO transactions have performed better than the CBOs over the past year in the U.S., and may do so in Europe as well," said George Sun, director, structured finance group at Standard & Poor's. "Loans can offer greater diversification and stability to a portfolio."
For its part, Barclays is focusing more on loans because its U.S.-based leveraged finance team has significant experience in this market. The recent additions: Hans Christensen, Martin Davey, Michael Reagan and Maria Cruz, all of whom previously managed the structured loans group at Citibank in New York, has shifted the group's focus firmly in the direction of syndicated loans.
"We had decided to develop this area of our business and so the availability of this group was fortuitous," Asarnow said.
In Europe, too, Barclays hired two new leveraged loan specialists, Faith Bartlett and Kevin Lennon, both of whom were with Fitch, earlier in the year.
More and more, the specific experience and expertise of managers are determining the make-up of CDOs.
The management team at Duke Street Capital, to name one example, has significant experience in the senior loans market, and subsequently, its Duchess I CDO - a EURO750 million arbitrage CDO launched earlier this year - was 75% senior loans, with the rest split between mezzanine and high yield bonds.
In some cases, a CDO may have two managers working together, thereby combining their knowledge of both markets, the high yield market and the loan market.
Ideally, the manager should have some flexibility to reallocate between high yield bonds and loans, as this provides more relative value opportunity, Asarnow said. In any case, demand for experienced managers, who can move from one asset class to another with relative ease, is on the rise in Europe as well. The number of CDOs being structured in Europe has been on the rise - in the first half of 2001 alone, five European CDOs were launched, whereas none were launched in the first half of 2000.
Market players believe that the asset class will continue to develop in Europe, as investors continue to appreciate the gains to be made.
"CDO equity represents an attractive asset class both for institutional investors and private individuals, and this augurs well for the development of the frequency and size of CDO issuance backed by non bank-aligned sponsors in the European arena," said David Wilmot, director of debt management at Duke Street Capital. " Investor perception of CDO management teams is key."