As the European CDO market comes in to its own, the market is seeing new assets in the mix. Such was the case in December with the GBP300 million Cairngorm transaction, which was the first synthetic CDO in the European market with a reference portfolio consisting entirely of leveraged loans
Cairngorm joins a rapidly ripening asset class, expected to generate a significant measure of interest among European market players in 2002. When it comes to leveraged loans, the number of experienced players is limited. Enter Centre, which has already participated in most of the CLOs with leveraged loan exposures. Centre plans to increase its penetration into the European ABS market through this vehicle.
With a growing number of European institutions exhibiting interest in this kind of structured product, the key to staying ahead is synonymous with experience. The European market has in the past year hosted three issues - Harbourmaster I, Duchess I and Cairngorm - and Centre has taken a leading role in both Duchess and Cairngorm.
Overall, this market has positioned $160 million to $170 million in equity, and Centre consumed $58 million to $60 million out of this universe of deals last year.
"We are planning to be involved in more transactions," said Daniel Riediker head of Centre's company in Europe. "We have a number of staff that have a leveraged loan background. We found the underlying business attractive and we saw opportunities in the CDO market, which is one of the core businesses we have identified for growth. We thought these two backgrounds would fit well together and we could add value. If you look at the heart of it, our role in Duchess as well as in Caringorm is to take an equity position in these CLOs of leveraged loans."
Cairngorm is structured as two linked transactions a GBP213 million unfunded senior credit default swap and a GBP87 million funded junior credit default swap through Cairngorm, a Jersey-based special purpose vehicle. Cairngorm Ltd. has raised funds to cover its potential obligations under the subordinated credit default swap and to repay principal by issuing GBP87 million of notes listed on the Luxembourg Stock Exchange. The Fitch rated notes range from a GBP28 million triple-A tranche to a GBP30.6 million unrated tranche. Centre provides GBP15 million of capacity in the Class E notes of the transaction.
Alfred Haslinger, vice president of Centre's company in London said, "With some of Centre's staff having a great deal of experience in the leveraged loan market, we were thrilled to see the securitization of European leveraged loans coming through last year. Combined with Centre's appetite for providing capital to this specific asset class, it seems only natural that Centre became the prominent equity participant in both the Duchess and the RBS transactions."
The biggest challenge for most players looking to enter this market is building an experienced staff with leveraged loan skills. While many firms desire to set up CDO teams, the teams already in tact have the advantage. "CDOs are coming into their own in Europe because of M&A activity and structural reforms," said Grant Gibson, vice president of Centre's London team. "We think that these structural changes will be accelerated with corporates under intense pressure to focus on divesting of non-core assets which has already resulted in some fire sales, all of which needs financing. The banking market can only supply so much debt and so institutional buyers have to come to market, with CDOs being a logical way for that to occur."
With only 30 "serious" banks buying leveraged finance in Europe, and with deals often exceeding one billion pounds, placing this debt can be challenging. Established CDOs players are next in line to pick up the slack, said Gibson.
With bank consolidation, the number of traditional participants is trending down.
"Before you had two market participants with equal appetites, the merged entity won't have an appetite that totals the two before," added Haslinger. "As a result the number of participants has gone down, and with the deals getting bigger, that creates open doors for new participants." Haslinger names Duke Street Capital as an example of a new participant. Duke managed the March 2001 Duchess I transaction. Without experience it's difficult to get hold of the right assets.
Elements for Growth
Despite the fact that the loans in Cairngorm are leveraged, there are numerous covenants in place to provide adequate enhancement. Additionally, the loans are from businesses that are "quite recession proof," Riediker said.
"Because of a generally more pessimistic view on the economy, the debt to EBITDA multiples of these loans aren't as high as in other vintage years and that makes the risk profile relatively more attractive," said Riediker. "In addition we have seen that spreads have been widening. These two points together mean there are fewer risks and more rewards, which make the asset class more attractive when compared with other years. With securitization of these loans, we also see a lot more liquidity come into this market."
Going Forward
Centre is currently working on a follow-up transaction to Duchess I, expanding the issue to EURO1 billion from EURO750 million. The deal is expected to close by the end of January. The company also expects to join Royal Bank of Scotland, manager of the Cairngorm deal, in a new transaction, as well as several opportunities the company has scouted with other management groups.
"2002 will be a good year for the underlying asset class of leveraged loans due to a decrease in the price expectations of vendors and leverages which has come down," said Gibson. "We expect that the underlying assets going into these transactions (CLOs/CDOs) should exhibit quite good performance in the next 12 to 18 months."
