BARCELONA - As structural innovation takes hold within the European CDO market, there has never been a better time for investors to pay closer attention to the kind of manager who will helm credit decisions, said speakers at Information Management Network's global ABS summit held here last week.
And while a number of CDO managers have cropped up in recent years to take advantage of the burgeoning sector, not all of them have been through rough credit cycles, market participants added.
"When you have managers that have a track record and know how to manage this risk ... this kind of flexibility I think is good for investors," said Hubert Le Liepvre, managing director and deputy head of the structured credit group at SG Corporate & Investment Banking.
Indeed, flexibility to trade out of a credit that is at risk of or is currently defaulting could mean the difference between whether a deal is downgraded or not. For instance, managed transactions holding troubled autoparts manufacturers Delphi Corp. and Dana Corp. were about half as likely to default when they announced bankruptcy than their static counterparts, speakers at the conference estimated.
New structures in the European CDO market are trending toward those that allow the utmost flexibility for managers. Opportunistic type structures, such as market value deals that incorporate a bucket of short credits, are expected to become more prevalent, speakers said. Also, a number of distressed debt desks are beginning to set up in anticipation of poorer performing borrowers. "We all know there is going to be a cycle, but we don't know what will trigger it," an investor said. Managers should be familiar with structures from CDO squared to Constant Portion Portfolio Insurance deals, a source said. And, ideally, they should have a management track record that has stretched back to at least the early 1990s - an indication that they have experience navigating through a rough credit cycle.
Specifically, panelists noted that a number of new managers have entered the CLO space - a rapidly growing sector in the European market that has held on to yield relative to other asset classes, making the deals more attractive. "I've seen a lot of managers of cash flow CLOs that have three years of experience, but that is three years in a benign credit environment," said Anne Wrobel, a managing director at Financial Security Assurance. And because the surge in both issuance and participants in this sector has created a strain on available collateral, a number of deals are relying on less traditional assets - such as second lien loans.
Brian McManus, head of CDO research at Wachovia Securities, estimates that about 3% of CLOs currently invest in second liens - what he called one of the "weak links" investors should look out for going forward. Speakers agreed that the so-called "other" buckets present in deals should be watched, because chances are managers do not have any specific experience with the collateral being placed in them. "We like the leveraged loan market ... but if I were to summarize it today, I'd say it is experiencing declining credit discipline," said Sohail Rosul, managing director at XL Capital Assurance. Rosul pointed to such loan collateral as "covenant lite," something that is beginning to erode deal credit quality.
"You can't model managers," said Victor Schneider, a director at Bankgesellschaft Berlin. He added that seeking managers with experience covering a particular asset class and actually visiting the teams face to face are key to choosing investment decisions.
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