Nineteen eighty seven saw the first collateralized bond obligation happen.
Imperial Savings, having securitized agency collateral - Ginnie Mae, Fannie Mae and Freddie Mac - was looking to securitize other high-yield bonds in its portfolio. The company decided to go to Drexel Burnham Lambert to help them package the bonds.
"Mike Milken, who was working for Drexel then, said that CBOs was a way to transform the high-yield market," recounted Robert Grossman, group managing director at Fitch IBCA. Grossman, who was then with Standard & Poor's Ratings Services, was part of the team that rated the Imperial Savings transaction.
Milken also believed that the CBO was a good way to provide capital to new and growing companies and to allow investment-grade debt to participate in the high-yield market.
"He was right," Grossman said. "But it took ten years to happen with all the macro-economic factors."
The Imperial Savings bonds had an average life of three years, reaching their maturity in 1990. "The interesting thing about this transaction is that even though the bonds reached their maturity in the midst of problems in the high-yield market, Drexel going out of business and the recession, everyone got their money back," Grossman added.
Imperial Savings followed its initial market-value CBO with a cashflow CBO offering in 1998. Two other landmark transactions followed in the same year. Grant Street NB used the technology for a good bank/bad bank transaction while New America came out with a close-end bond fund "where the analytics were very similar to a CBO."
In 1994, Mass Mutual Corporate Value Partners came out with the first multi-asset CBO/CLO. The company's portfolio included bank loans, private placement, high-yield bonds and special situations.
"It's the first transaction that I'm aware of that had a number of different assets," Grossman said. "It made a lot of sense for them because the company had a significant experience with all these assets and they were the first who did a relative-value CBO."
Issuance Upsurge and Innovations
Though a lot of innovative transactions appeared in the market beforehand, 1996 was the landmark year in terms of the increase in CBO/CLO issuance. Ranging from $600 million to $3.8 billion, CBO/CLO issuance rose to $18.6 billion.
The year also saw NatWest's landmark $5 billion CBO offering, which was tranched out in both dollar and sterling-denominated pieces. The transaction, which was done through Rose Funding, was structured under Rule 144A. Another notable deal that happened in the same year was Oakhill Securities Fund's $2 billion multi-asset, market-value CBO.
The delay in the growth in the CBO/CLO market can be attributed to the fact that investors needed time to warm up to the product as well as some macro-economic factors that occurred in the early 1990s.
"You need a relatively sophisticated investor to buy a CBO," Grossman said. "The asset-backed market was relatively new then and even credit-card securities were viewed as risky. So it took a long time for investors to get comfortable."
The recession that started in 1991 also caused a lack of liquidity in the high-yield market, hindering the growth of CBOs/CLOs. But after the crisis, there was more room for growth in the market.
The heavy redemption from high-yield bonds in 1991 taught managers that having a longer-term vehicle was beneficial. Through the CBO/CLO structure, the money is usually locked for years and can only be unwound in very unusual circumstances.
"I think the managers liked it because they could take a longer-term approach to investing, and they wouldn't have to worry about redemption like they would do in an open-end fund," Grossman said.
"Since investors had been through the recession in 1991, people felt that they have been through the worst in terms of the high-yield market," Grossman added. "Also, the bonds and the loans were becoming more liquid so it was easier to put a deal together."
The performance of the bonds also encouraged investors to be more open to the product. "Ten years ago, it was not easy to convince investors to buy high-yield bonds being managed by someone else," Grossman said. "But now since a certain amount of time has passed, the history has been good, it has become more popular."
After the tremendous spurt of growth came the innovations in 1997. A remarkable development was the first use of synthetic instruments, particularly credit-linked (CLN) notes. CLO Swiss Bank Corp. launched the first CLN-backed transaction in September 1997.
The year also saw the first time the Master Trust Structure was used. Four transactions including issuances from Swiss Bank Corp. and NationsBank were launched.
In 1998, DLJ Leveraged Loan Fund securitized its trading portfolio of loans. Aside from this, there were more securitizations of synthetic instruments that occurred after the summer of 1998.
What it Was Then and What it is Now
Grossman said that CBOs/CLOs have evolved from being a vehicle with a specific purpose to a corporate-finance tool.
Historically, financial institutions would choose to securitize different asset types such as residential mortgages, commercial mortgages, and auto loans but would keep corporate loans on the balance sheet.
"Now, banks can look at any asset on their balance sheet and sort of separate the origination decision from the funding decision," Grossman said. "By that I mean the bank will make the loan and then make a separate decision to keep it on-balance-sheet or to sell it." S
