For Lincoln Investment, Name of the Game is CBOs


In their quest to identify attractive relative value and wide yield spreads in the asset-backed securities market, investors at Fort Wayne, Ind.-based Lincoln Investment Management Inc. have zeroed in on both an asset class and a marketing environment that works exceptionally well for their portfolio: collateralized bond obligations in a private placement-style setting.

"We absolutely see more attractive returns and value in the subordinated tranches of CBOs (collateralized bond obligations) and collateralized loan obligations (CLOs), as well as in emerging asset classes such as mutual fund fee securitizations," said Steven Staggs, vice president for private domestic structured finance at Lincoln. "Moreover, we're looking for deals where we can add value by performing private placement-style due diligence."

With approximately $950 million devoted to both CBOs and CLOs, these repackaged high yield bonds have been nearly an obsession for the company since late 1998.

In Staggs' opinion, investors can benefit most from these emerging classes because a premium is received for the perceived illiquidity in the market, leading to widening spreads and an attractive return on the investment.

"The illiquidity is a function of the fact that some of these asset classes have not been broadly accepted by institutional investors," Staggs said. "Therefore, we look across all asset classes and credit sectors for relative value. As a buyer right now, the spreads are very attractive for CBOs and in the future you'll see spreads tighten as a result of increased liquidity and increased receptiveness by investors to that asset class."

For instance, Staggs points out that triple-B-rated tranches of CBOs have priced at 325 basis points over Treasurys recently, and double-B tranches have been priced anywhere from 650 basis points to 750 basis points over.

"This is a substantial premium to comparably rated high yield bonds," he noted.

Mutual Fund Fee Paper Ranks No. 2

Out of Lincoln's overall portfolio of $36 billion, $2 billion is dedicated to private domestic structured finance, and that amount is divided between CBO paper, mutual fund fee-backed paper and a variety of bonds from other emerging asset classes. Staggs does not look at credit-card or auto loan debt, however - they are already too recognized by a broad array of investors to suit his taste.

As one of the first investors to take an interest in mutual-fund fee securitizations three years ago, however, Lincoln touts that asset class as one of the most attractive in terms of spread.

"It was an asset class that had the characteristics similar to those we were looking for, truly fitting in with our skill sets here at Lincoln," Staggs said. "It had characteristics that were analyzable and it was something we could perform due diligence on, and the prospects for similar transactions coming to market in the future were good, which, generally speaking, results in increased liquidity and tightening spreads. So we felt there was some upside in the asset class."

Currently positioned with approximately $150 million in mutual fund fee-backed paper, Staggs says that the supply and demand imbalance implicit in an asset class such as this provides a much-sought-after spread premium, and spreads will only tighten after investors become more acquainted with this particular class.

"Generally, spread tightening in that asset class occurs as liquidity increases, and as more institutions look at that asset class as a yield-enhancing vehicle," he noted.

Take A Walk On The Private Side

An equally important aspect of the company's overarching investment plan is the due diligence and analysis process, which seems to be most effective when played out in the private placement arena.

"We spend more time analyzing the capabilities of the originator, servicer or collateral manager than on any other aspect of the deal," Staggs said. "And because the private placement market is less efficient than the public bond market, there is the opportunity, through intensive due diligence, to identify inefficiencies in the market and exploit them."

The vast majority of CBOs which Lincoln is interested in are issued in the Rule 144A market without registration rights - what Staggs calls a "true private placement."

"In addition to conducting private placement-style due diligence, we want to make sure that our collateral manager has a strong analytical infrastructure, strong back-office infrastructure and we especially want to know that it s analytical resources are deep and appropriate to the asset class being invested in," Staggs noted.

With such intense focus placed on the due diligence process, Lincoln hopes to guarantee that the asset manager exhibits the ability to consistently and successfully execute a clearly articulated strategy.

Overall, ABS looks very attractive to Stagg's private fixed-income shop for the millennium, and he predicts that spreads will tighten because of an influx of cash flow to several of the asset classes, "and partially because of a general tightening of spreads... as Y2K fears pass."

At this stage, Staggs is especially tuned into securitizations of music royalties and entertainment rights, structured settlements and the securitization of other intellectual property.