CDO management contracts continue to trade well

Prices for CDO management contracts continue to trade well. The window of opportunity will only last as long as the new issue CDO market remains broken, however.

Matt Natcharian, head of structured credit investing for Babson Capital Management, confirms: "Prices for CDO management contracts are trading well because there is so much demand for them, with managers looking for a mix of both complementary and new areas of businesses to add to their platforms."

He says this is being driven by the fact that there's no active new issue market and so medium and large managers are looking for ways to grow, helping ensure they remain a significant player in the market. "It has been tougher for smaller managers to continue building their businesses, so they are taking advantage of this opportunity."

The most recent sale is believed to have traded at above 50% of the manager's expected revenues, with over 20 bidders involved. "Certainly CLO management contracts are valuable and many managers would be interested for the right transactions, but even for large shops - where there are economies of scale - some of the prices may not prove to be profitable for them. The conclusion I draw is that some managers are focused on maintaining their market scale," Natcharian adds.

But while selling activity remains strong for the moment, he warns that the window of opportunity is small - essentially until the new issue CLO market returns. Managers will have little incentive to buy or sell businesses once the market begins improving.

In an analysis of US CDO manager mergers and acquisitions occurring over the past two years, S&P has found that motivations for such activity appear to differ between 2009 and 2010. "It is our view that in 2009 a push for economies of scale resulting from an overall decline in management fees was the primary factor driving M&A activity. In 2010, with subordinate overcollateralisation ratios rising for many CLO transactions - and management fees picking up again, as a result - the motivations for M&A activity appear to be more diverse," the agency notes.

Some of the driving forces seem to have included investor actions to remove and replace a collateral manager (see also separate News Analysis), financial issues at certain parent companies of collateral managers and a desire by parent companies to move away from the CLO market, according to S&P. "In our opinion, these M&As still resulted in economies of scale, however, as many of the acquisitions involved no increase in personnel for the acquiring organisation."

So far this year, the agency counts nine separate collateral manager mergers or acquisitions, involving 33 separate CLO transactions and one CBO transaction. In all of 2009, there were 14 separate M&As involving 46 different CLO transactions.

S&P reported one CLO manager M&A for August: the replacement of A.C. Corp by Ivy Hill Asset Management on the Knightsbridge CLO 2007-1 and 2008-1 transactions. Further consolidation opportunities look set to emerge with the recent bankruptcy filing of GSC Group.

Capstone Advisory Group has been retained to auction off GSC's US$8.65bn structured finance platform. It is understood that the firm's CLO management obligations will be included in the sale.

According to S&P, the collateral management agreements for the CLO transactions contain provisions permitting some combination of noteholders and equity holders to agree to replace the collateral manager upon the bankruptcy of the existing collateral manager. It rates 12 CLO and 11 ABS CDO transactions managed by GSC Group and its affiliates.

CS