June 27, 2007
The following is an excerpt from an article in The Bond Buyer of the same date, covering a panel of market experts at a World Research Group conference discussing municipal collateralized debt obligations, or CDOs. The panel included four professionals who helped structure, sell, or buy the market’s landmark CDO-styled deal, Non-Profit Preferred Funding Trust I.
Non-Profit, more than the other handful of similar deals being marketed, provided significant spreads above yields on cash bonds, said Tom Weyl, manager of municipal research at Eaton Vance Management in Boston. He said that the potential for credit-spread widening was the biggest hurdle to investing in the deal.
A group led by Merrill Lynch & Co. and portfolio manager Cohen Municipal Capital Management began marketing the Non-Profit trust last fall. It was designed like a collateralized debt obligation, or CDO, with about $416 million of total par volume and a 250-day ramp-up period, according to rating agency reports.
Since then, news of at least two other CDO-styled structures have surfaced. UBS Securities LLC is set to close next month on Republic Funding Trust I, a $400 million deal comprising more commonly known and traded credits. Investor sources also said another deal similar to the Republic trust is also making the rounds, though Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s all said that they have not yet rated a third such a deal.
Like the CDOs found in other fixed-income markets, the tax-exempt versions take an underlying pool of credits and repackage them into stratified tranches, allowing investors to buy trust certificates rated as high as triple-A and as low as an unrated equity-styled level. The muni-based deals are referred to as structured tax-exempt pass-throughs, or STEPs.
About $320 million of the Non-Profit trusts’s certificates were created to get triple-A ratings, while about $16.5 million were to be rated double-A, and $22 million were to be single-A. The bottom tranches included $14 million of triple-B debt and $44 million of unrated securities.
Weyl, said on the panel that his firm purchased “most of those intermediate classes.” He added that they considered buying the lower tranches, but would only buy these levels if Eaton Vance could have a say in which credits were added to the underlying pool. The “ramp-up risk” of not knowing exactly what would underlie the certificates can often make such deals tough-sells with internal credit control officers, he said.
Investors tended to require a 25 basis point premium on the Non-Profit trust to account for the illiquidity of such a new structure. Much of the triple-A class was added to various firms’ tender-option bond programs, though Moody’s said it has not seen any of these certificates put into the programs it monitors, and Fitch said it has only seen them in a few programs.
Using the certificates as the long-term investment in this carry-trade strategy allows the tender-option-bonds programs to offer their resulting short-term floaters with about five basis points more yield than they can with cash bonds, according to a panel of market experts attending a World Research Group conference on June 26.
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