Safety Conscious Buyers Turn to HY


While many traditional private placement investors stray from the lower end of the credit spectrum, a number of advocates of the riskier tranches say the addition of subordinate asset-backed bonds can significantly enhance a private placement investors portfolio.

"If you are comfortable with the senior securities it makes sense to start looking down a bit at lower rated tranches," said Sheila Sohr, managing director at PPM America.

Even in somewhat volatile market conditions, that belief apparently is shared among a healthy number of investors. In fact, some buyers are even seeing increased opportunity to buy lower rated deals as most flock to safer, higher rated issues.

Indeed, some insurance companies, which have always traditionally invested in double and triple-B rated securities are putting more towards subordinate tranches, including single-B opportunities, sources say.

Part of the reason for the increased volume in this area is the phenomenal growth in CBO/CLO product that uses these securities as underlying collateral.

"A secondary market is going to be growing out of a need for more CBO product from different types of buyers," said Bruce Maier, vice president at Structured Finance Advisors. "As the CBO market is trying to accumulate collateral [the subordinated market] may be a basket for activity."

When Good Deals Go Bad

Of course though, subordinate investing must be done with extra care; it requires timing, good relationships with seasoned agents and an exhaustive amount of due diligence.

"When looking at emerging market or new asset classes, corporate data is hard to find," said one market pro. "You need to do all the stress tests and what if's'."

"We like to look at the pricing on the underlying collateral especially with CBOs," said PPM's Sohr. "We've seen some with problems and if you look at the underlying capital you'll notice it was at a time of very tight spreads."

She also stresses establishing a "framework" for pricing, looking at relative value across all sectors in the private and public asset-backed securities.

"Often you are the lost piece," said SFA's Maier, explaining the reality for investors when a transaction goes sour. "The subordinate piece is probably going to be affected. The equity portion, which is usually small, gets eaten up pretty quickly."

Runinng Down The Monoline

And while monoline wraps, a popular mechanism in the structured market these days may make transactions cheaper for issuers and ultimately safer for senior buyers, they give many subordinate investors the willies.

Sources say that as the "third party" in transactions, monolines like MBIA, are on the line to ensure payment of bonds, especially to senior holders, and as such can shut off payment to subordinated note holders.

"A monoline has to react very quickly. If a monoline is in [the transaction] we will ask for a lot more due diligence," said SFA's Maier. "Third party agreements will affect the sub holder maybe even more than the original documentation."

So it appears the risks are great for subordinated note buyers in credit wrapped transactions, but somebody is buying them. As one investor put it, "People do it but I'm not sure how they deal with [risk]."

Much like spreads, the risk involved only increases when the bonds on the table are cross-border or emerging. "We try not to do weak credits in a weak countries," said PPM's Sohr.

Timeshare loans, franchise loans, music royalties, mutual fund fees and leasing transactions were identified as the providing the most valuable opportunities in the subordinate market. Considering the buy-and-hold nature of private placement investors, the fourth quarter should provide a number of opportunities, sources said.