Cohen and Co. is in the market with a $408 million cash-flow trust preferred CDO, ALESCO Preferred Funding XVII. The deal will be the 22nd trust preferred transaction completed by Cohen & Company Financial Management and its affiliates, but it might not be the most profitable. Market players speculate that the company might only break even, if not take a loss on the transaction, in a move they see as an effort to promote market liquidity.
"They are doing this transaction to create the impression of liquidity in a very dry market," said a CDO manager, who noted that though the transaction is expected to close at the current pricing, Cohen might take a loss on the deal because the collateral was bought at much tighter spreads before the summer mortgage mess.
Others agreed. "You can do the deal at a loss, or you can liquidate the collateral and have an even bigger loss. Sometimes that is the choice. It comes down to the lesser of the two evils," said another CDO manager, who thought it was likely the tranches could be sold at a lower spread than the official pricing.
Pricing on the deal is at 95 basis points over the three month Libor for the $6 million A-2 tranche, 100 basis points over the three month Libor for the $44 million B tranche and 150 basis points over the three month Libor for the $42.5 million C-1 tranche, according to a report from JPMorgan. The $34.2 million D class of notes was at 275 bps over the three month Libor.
One CDO market participant noted that the deal looked thinly priced because of the problems in the housing market, which banks issuing these types of securities are exposed to. "Banks are facing subprime issues, and who knows how bad things are. In this market it is just not worth it," he said, adding that banks could stop paying the trust preferred security, and it would not be an event of default.
Indeed, banks are taking a big hit in third-quarter results as a result of their subprime exposure. Merrill Lynch announced a write down of $7.9 billion in CDOs and U.S. subprime mortgages last week, in addition to an overall net loss of $2.3 billion for the third quarter (see Whispers pg. 6). "Mortgage-related losses including subprime, Alt-A, prime and home equity lines of credit will continue to rise as home prices decline, and banks will continue to bear the brunt of those losses," Chris Flanagan, head of global structured finance at JPMorgan, said on a conference call last week.
Back To Basics
The ALESCO transaction will issue $408 million of floating-rate notes, hybrid-rate notes and preferred shares, according to a Derivative Fitch presale report. Proceeds from the sale of these notes will be invested in a $400 million portfolio primarily consisting of trust-preferred securities and subordinated notes issued by banks and thrifts. In addition, a small portion of the portfolio is expected to be composed of subordinated notes issued by derivative product companies (DPCs), Fitch said. The structure is generally the same as Cohen's previous trust preferred CDOs but with slightly more credit enhancement and 100% bank securities, whereas the previous transactions had buckets for insurance, Fitch noted.
At closing, the portfolio is expected to be 87% ramped with a four-year substitution period, during which the collateral manager may reinvest principal proceeds from the sale of defaulted, credit risk and equity securities in substitute collateral, Fitch said.
In addition, the co-issuers will hedge the unmatched exposure between hybrid and fixed-rate assets on the one hand and floating-rate note obligations on the other with an interest rate swap with a notional amount of $30 million for the first five years, which will then be reduced to $4.8 million for the next five years, according to Fitch. The fixed-strike rate is expected to be set at 5.03%.
Cohen and Co. declined to comment on the fund, citing the quiet period they are currently in.
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