Investment bankers looking to inject life into a moribund market are
pushing one of Wall Street's more novel repackaging ideas: turning
junk bonds into investment-grade securities.
The collateralized bond obligation, or CBO, has grown from
scratch into a multibillion-dollar market in two years.
Some bankers think the market's size could double this year
alone, and in the process bring some fresh demand into a junk-bond
market sorely in need of buyers.
``I think it has some potential to grow because what it does is
put bonds in the hands of long-term holders,'' said Timothy P.
Norman, a vice president at Duff & Phelps Investment Management,
which manages more than $25 billion from its Chicago offices.
Norman manages one of the biggest CBOs done to date, a $301
million deal completed last November.
The concept, he said, is sound even if the idea of turning junk
into grade-A investment material seems like financial alchemy.
The CBO pools bonds issued by a number of different companies to
minimize the risk of defaults. Then, it apportions interest and
principal payments flowing from the junk pool to several tiers of
The top tier or tiers has first priority to payments. Only
after they receive their interest and principal does money trickle
down to investors at the bottom tiers, where the risk as well as the
potential returns are much greater.
``You're able to take a pool of junk bonds and basically carve
the risk up and sell it to a buyer who wants a part of it,'' says
Andrew Kimball, an associate director who helps issue ratings for CBO
deals at Moody's Investors Service.
In Norman's case, Duff & Phelps bought just over $300 million of
junk bonds, repackaged them under the name of D&P CBO Corp. and then
sold off stakes of the pool to four classes of institutional buyers.
The top tier, totaling $240 million, got a solid single-A rating
from Standard & Poor's Corp.
Investors buying into that tier - mainly insurance companies -
were promised a return of 10.05 percent over an average life of
seven years. That was a little more than 1 percentage point above
the yield on conventional single-A-rated corporate bonds at the time
the deal was done, Norman said.
The next level, having a subordinated claim on payments from the
pool, totaled $45 million and was priced to yield about 13 1/4
percent, Norman said. …