The newly hatched CDO group at Financial Guaranty Insurance Company closed its first transaction last week, providing secondary insurance to an investor on a CLO backed by senior secured loans.
"We closed the secondary policy on the same day the CLO closed," said Tracy Pridgen, managing director and head of FGIC's CDO group. "We were working with [an investor] who only wanted to participate in the transaction on a wrapped basis."
The class in question was already structured to a triple-A rating, but the investor was looking for additional protection. Furthermore, taking out insurance on this position could be viewed as a hedging strategy. A lot of the investors buying these bonds today are credit trading desks, looking to hedge the risk on their trading books. "For hedging purposes, they will sometimes buy protection for a position on their trading book," Pridgen said.
As a secondary party, FGIC let the documentation stand largely as it was written. The monoline wasn't looking for a so-called "diamond in the rough," Pridgen said. Rather, the monoline's strategy going forward is to target high quality positions where very little additional clean up is necessary.
"We didn't want to impose our specific views," added Beth Nugent, a director at FGIC. "We chose this deal in part because it was consistent with our views of how a CLO should be structured."
Furthermore, the asset manager on this CLO had never worked with a monoline before.
"The [manager] was a bit apprehensive about working with a monoline. But they were able to get comfortable with the idea that we were not there to be obstructive to the process - we were there as investors that had a particular interest in an asset manager of that quality," Pridgen said.
FGIC's relationship with a single investor in this transaction is indicative of a larger trend in the modern CDO era. As investors have become more comfortable with the structures, the CDO market has moved away from involving the monolines on a primary basis. Ever-tightening spreads are also driving the trend. "The spreads on the underlying collateral and the pricing of the liabilities has come in substantially, so there is not significant excess spread, and not a lot of money that can be paid directly from the deal," Nugent said.
Pridgen drew a distinction between FGIC's role in this instance and what might be deemed a "true" secondary wrap, in which a monoline would enter the picture at some later point in the life of a transaction. While FGIC will consider providing this type of insurance for existing clients, it is not expected to be a major part of the group's business, Pridgen said.
Moving into the fourth quarter - a historically active time of year for the CDO market - FGIC is seeing a full dealer pipeline, and anticipates completing two more transactions before the year is through. "We are a small team, so our strategy is to be very selective," Pridgen said. "These are generally cash deals focused on senior secured loan products, with a typical size of between $300 million and $400 million."
Pridgen began building the four-person CDO team at FGIC after joining the company in April from Rabobank. In addition to making new hires, FGIC moved over internal staff with previous experience in CDOs. "In the six months since I came on board, we have been able to move rapidly in part because many of the pieces were already there - they just needed to be brought together," Pridgen said.
FGIC was purchased by a PMI Group-led group of investors last year and emerged from under the aegis of General Electric Capital Corp. as an independent operator. The launch of its CDO business is part of the monoline's strategic redirection.
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