Following a string of significant hires and the realignment of several origination efforts, Merrill Lynch could once again be a player in the asset-backed league tables, intentionally or not. The bank, which consistently owned the market throughout the 1990s, literally fell off a cliff in 1999.
First off, Merrill is back in home equity, which represents roughly 40% of the total ABS market. The bull finished 2001 without a dime of credit in real estate ABS, and booked less than $3 billion in 2002. So far this year, the Merrill has brought $7 billion in home equity - $4.1 billion in the last three months alone (though everyone is benefiting from this year's mammoth run in home equity product, up 73% half-over-half, and up 50% annualized). Still, at 4.8%, Merrill's market share of real estate ABS roughly triples its 2002 activity.
Most visibly, however, Merrill should show a significant pickup in CDO activity during the second half of 2003, following the hire of Chris Ricciardi from Credit Suisse First Boston, who had led CSFB's top ranking investment-grade CDO effort until February. Ricciardi heads Merrill's entire CDO effort - investment grade, high yield, you name it. Ricciardi brought with him a few notables from CSFB, including Lars Norell, who will lead the CDOs of ABS effort, and Harin DeSilva, who will head the new assets and synthetic effort. High yield is being run by David Blackwelder, a director reporting in to Ricciardi, who in turn reports to Mac Taylor, head of global structured products.
"Management has made it pretty clear that they are committed to this business, and staffing it appropriately is one clear signal," Ricciardi said. "And I think you'll see a lot of other things coming out of this firm, which indicate a commitment as well."
While CDOs won't do much for Merrill in the overall ABS leagues - they represent only about 5% of the public and Rule 144A market - this is nonetheless a hotly watched area of structure finance. CDOs do account for about 32% of 144A volume, however.
Pre-Ricciardi, the bank has led just one deal this year from the high yield CDO sector, for about $300 million in league table credit. Merrill has a more substantial pipeline in place for the second half, Ricciardi said. "I'm pretty confident [we will be bringing] more than one deal," he joked. "Once we are up and running, we will absolutely be one of the top firms in CDOs."
ASR's pipeline shows Merrill with at least three deals pending, including a $1 billion range synthetic CBO of investment-grade bonds for MBIA Capital Management, plus a $300 range trust preferred securities-backed CDO for Dekania Capital Management. It should be noted that neither Ricciardi nor anyone else at Merrill commented on these transactions or any other specific deals still in the market.
In 1995, Merrill nearly tied CSFB for the No. 1 spot in total ABS sold, with about $20 billion in proceeds, which back then was nearly 20% of the market. Throughout the late 1990s, the firm continued to trade in and out of the top ranked spot with CSFB and Lehman Brothers, and the former Morgan Stanley Dean Witter and Salomon Smith Barney.
Merrill ended 1999 in the No. 6 spot, and subsequently slipped to No. 10 by the close of last year. Currently, Merrill is outside the top 10 in the year-to-date league tables, though edged back in slightly for stand-alone second quarter numbers.
Where Merrill ends up this year in the ABS leagues depends partly on where the bank finds the best execution for its principal finance-related origination. As part of a major new initiative launched last year, Merrill formed its Global Principal Investments and Secured Finance (GPISF) group, headed by longtime Wall Street bigwig Jeffrey Kronthal.
As head of global asset-based finance, securitization and principal transactions, Michael Blum oversees the new origination effort tied to GPISF. Prior to GPISF, Blum ran the principal finance group at Merrill. He is an 11-year veteran of the firm.
"Before GPISF, what we had was several disparate businesses - all profitable and good businesses - but separate, with different priorities and agendas," Blum said.
The principal finance group provides liquidity to corporate clients that are originating cashflowing assets. This includes everything from equipment lease portfolios to wholesale mortgages. Theoretically, with the principal finance and securitization efforts under the same umbrella, it's likely that Merrill will take its corporate borrowers to the ABS market, if it's an option that provides the best execution. Merrill is also pledging its balance sheet and, in some instances, bringing on reinsurers to reduce its exposure.
"We're able to participate on the opportunistic front. Where there's a distressed situation, we're also able to purchase assets and provide liquidity," Blum said. "We're getting early calls on, or even first calls on, transactions in which a year ago we may not have even received a call."
Currently the bank's asset-based finance business is 80% generated in the U.S. and 20% international, split equally in the Europe and Asia. Merrill intends the international figure to eventually represent 25% of the business.
Beyond Ricciardi and the expansion of the CDO group, Merrill recently hired Peter Hoffman as a director from FleetBoston Financial Corp. Hoffman specializes in new assets, intellectual property and sports finance, and has experience on some significant esoteric transactions and financings, such as the Dreamworks deals that Fleet participated in.
Last year, Merrill hired Mathew Whalen as a managing director to head its real estate securitization group. On the real estate origination end, Merrill added Jamie Willeck as a director from GMAC-Residential Funding Corp., to head its Specialty Underwriting and Residential Finance (SURF) group out of Minneapolis, which has been staffed up significantly over the last six months.
For credit cards, Merrill hired John Kim as a director from CSFB, reporting to non-real estate securitization group head and Managing Director Ted Breck, who has maintained Merrill's strength in equipment and student loans over the past few years.
Merrill will also be active in the aircraft finance sector, and was a co-manager on last week's EETC issue for American Airlines.
"We are certainly reinvesting in these businesses," Blum said. "Clearly, prior to a year ago, we were under-invested in the structured finance business. We have made it an initiative over the last year to bring sufficient resources to this business at Merrill Lynch."
The universe of collateralized debt obligations has expanded in leaps and bounds since Ricciardi entered the sector in 1997. Prior to CSFB, Ricciardi was structuring CDOs at Prudential Securities.
Under Ricciardi, Merrill's revamped CDO group will add TruPS-backed (trust preferred securities) and structured product collateral (ABS/RMBS/REITs) to its focus universe, which traditionally included CLOs and synthetics.
"If you look at the CDO market just four years ago, it was all high yield product. These other asset classes didn't exist," said Ricciardi. Today, he estimates the vast majority of CDO activity is in the ABS and TruPS area, with about 25% to 35% remaining in high yield leveraged-loan products.
Merrill's new group will function as one unit, rather than having separate product groups with separate reporting lines for each collateral type, as is the model at other firms. "One group does all the CDOs, regardless of the region, regardless of what the underlying asset is, and regardless of whether it is cash or synthetic," Ricciardi said.
The one-stop shop concept will also help the group (and its profit profile) weather market volatility. Economic and structural shifts tend to benefit different CDO products at different times, and can lead to changes in deal volume when certain asset classes become popular and others fall out of favor. For example, the managed synthetic investment-grade market is essentially dormant from the tightening in corporate spreads. On the other hand, CDOs of mortgage-related product are still able to capture an arbitrage.
Taking into consideration the vast size and depth of Merrill's brokerage business - as well as the potential uptick in securitized products - the CDO team could benefit from the different lines for sourcing collateral, especially on the trust preferred securities front.
However, Ricciardi stresses that, when working with a third-party collateral manager, the bank structurers are ultimately not selecting the assets.
"If you are doing a deal with a third- party manager, they're the ones who are deciding what goes in and what does not," he said. "On one level, if there is much more volume in and around the product area, it can be helpful for both parties, but its not like there's anything more than that," he said.
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