Though there has been some collateralized loan obligations done in Canada (Dominion Bond Rating Service Ltd. figures there are $900 million outstanding), CLO activity has not been significant, and the reception to the product has been somewhat lukewarm.
"Response to the product has been mixed," said Barbara Hooper, managing director of asset securitization at TD Securities. "I know of one bank who is looking at it fairly seriously and another that has said that doing a CLO is not a priority." TD Bank did a CLO in the fall of 1999.
However, this doesn't rule out the possibility of an expansion into the CBO/CLO arena as market players in Canada look into newer asset types.
"People are starting to look more to other asset classes," said Louis Neretlis, senior financial analyst at Canadian Bond Rating Service. "We have started to see the CMBS market develop in Canada over the last year or two and I think it's going to be a natural progression into other asset classes. I think the CBO/CLO will be one of those."
One problem in Canada is the extent of its bond market. Neretlis said that the Canadian bond market, especially high-yield, is not as deep as the U.S., nor does it have the same diversity.
David Allan, managing director and head of securitization at CIBC World Markets Inc., explained that there is not a whole lot of public debt at decent spreads because most of the product that's originated in Canadian dollars are senior pieces that have investment-grade ratings so, they are relatively low-yielding. "Most of the high-yield debt Canadian originators issue is issued in the U.S. market, and much of it is U.S. dollar-denominated," he said.
Not Enough Buyers
One possibility, sources say, would be to combine loan product and bonds into a CDO. But because a lot of the sub-investment-grade loan product that the banks generate is not rated, a problem would be getting them up to the rating standards needed to comply with CDO structuring requirements. Furthermore, since most of the loan products on the books are probably underpriced for the risk level that they would translate to on a rated basis, the returns would be lower than they should be when they are structured into a CLO.
Moreover, a lot of the loan product is also insufficiently diversified by industry. This is because the Canadian industrial base is a bit more concentrated than in the U.S.
"So when you apply the diversification scores required to structure a CBO/CLO, the structure requires more equity and the yield you can generate on that equity is therefore low." Allan said, "which means it's very difficult to find buyers to form the backbone for your CDO because you can't provide an adequate return."
Allan said a more significant Canadian high-yield market has to be developed with much more diversified sources of debt. "One of the ways to do this is to use high-yield asset-backed product as part of the mix."
He predicts more mixed pools ahead. Future CDO structures "will necessarily include both corporate and asset-backed bond product, on the assumption that, for a number of reasons, it is a lot easier to hasten the availability of high-yield asset-backed product then it is to try to hasten the issuance of significant amount of high-yield corporate-bond product."