Investors are soon to have another chance to buy into the first managed, publicly rated CDO backed by so-called commodity trigger swaps. Barclays Capital last week closed the roughly $100 million first offering of Everest I - the first-ever managed deal of its kind and only the second deal backed entirely by commodity trigger swaps to be publicly rated.
A second close of the deal is in the works, according to Jeffrey Sherman, a vice president at Trust Company of the West. The transaction priced some 100 basis points wider than most new issue CDOs, the deal's arrangers said - a factor that, along with its touted benefits for portfolio diversification, could draw a number in the yield-hungry market.
"We anticipate multiple closings for this structure. We think, as is the case with all these things, we will find imitators out there that are going to do this," said Claude Erb, a managing director and lead portfolio manager on the deal at TCW. Others may not be far behind in following in Barclay's footsteps, with at least one CDO in the works backed by corporate credit default swaps and commodity trigger swaps. Standard and Poor's is the only rating agency publicly involved in the structures.
Everest references a portfolio of 100 commodity trigger swaps - similar to credit default swaps. The deal has a five-year life and an S&P AA+' weighted average rating. The swaps at the deal's close referenced nine commodities - primarily base and precious metals. The terms of the deal allow for up to 16 different commodities and a 20% portfolio turnover each year of the five-year transaction. Eighty percent of Barclay's Everest notes, marketed globally, were issued in euros, while 20% were U.S. dollar.
Diversification through commodities
As the market grows weary of credit risks associated with rising U.S. interest rates, lagging home prices and the specter of a downturn in corporate credit, some are expecting the commodity-linked investments to become more prevalent as players look to diversify. According to Erb, "there is no indication" that movements within the commodities market are correlated with any of the above mentioned risks. Barclays said applying the CDO technology to commodities was a natural step in the evolution of the market - which has grown from a range of products based on the commodity indices, to structured notes taking directional views. As of last year, Barclays was the largest dealer in commodity-linked notes, issuing some $2.7 billion. Its team pioneered the CCO market in December 2004 with a static deal.
Now, Everest's arrangers say the ability to lightly manage the deal could improve performance because of the opportunity to exploit price fluctuations within more volatile commodities markets such as energy. The nine commodities referenced in the Everest deal - silver; platinum; aluminum; copper; nickel; tin; lead; and zinc - have trigger prices ranging from 46% of the commodity spot price at the deal's close to 12%, according to S&P. The other seven commodities that could be referenced during the life of the deal are relatively more volatile. These are gold, West Texas Intermediate, Brent crude oil, heating oil, gas oil, natural gas and unleaded gasoline. There are between eight and 16 trigger swaps per commodity. The swaps are valued for a 10-day time period, falling 20 days prior to the deal's close. A trigger event occurs when one of the commodities falls below its predetermined valuation price, and there are no recoveries. If a trigger is hit, the payments are fixed and equal, despite commodity type and divergence from the trigger amount.
High yields to draw buyers
Institutional investors are expected to be the primary market for the product. "By using CDO tranching methodology, the CCO offers investors commodity risk in a format they are used to," said Martin Woodhams, co-head of commodity structured products and principal investing at Barclays. "The yield on the product is also very attractive compared with other similar rated transactions."
Indeed, like any untracked sector, the yields on the notes are relatively high - a reason alone investors may be inclined to try them out. Interest was particularly peaked in the highly rated triple-A and double-A tranches - which priced at 120 and 205 basis points over Libor, respectively, according to Erb. Meanwhile, spreads from leveraged loan CDOs to ABS CDOs are at or near record tights, a phenomenon that has sent investors in search of yield, and structurers finding ways to create it.
As of June 1, new-issue triple-A mezzanine structured finance CDO spreads were averaging 32 basis points over Libor, according to JPMorgan Securities, while double-A spreads on the deals had tightened five basis points from the previous week to 55 over Libor. Double-A high yield CBO tranches had also tightened five basis points, to 55 over Libor, while triple-A HY CBO spreads were at 30 over Libor - five basis points tighter than yearend levels.
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