Facing a sluggish trading environment, an increasing number of private equity firms are raising funds by issuing mortgage fund bonds (Cfos). This type of bond packages and cuts illiquid assets into high-rated securities, enabling issuers to raise funds at a low cost. Recently, institutions such as Ares Management Corp. and AlpInvest under Carlyle Group have joined the ranks of Cfos issuance one after another.
Private equity firms are actively seeking new sources of liquidity, especially against the backdrop of intensified market volatility and the shrinking of traditional deal-matching businesses this year. Cfos, supported by the cash flow of highly leveraged assets, have become one of the solutions. Greg Fayvilevich, the global head of Fitch Ratings, said that there are new CFO proposals every week and the market is expected to continue to grow.
Starting from January 1, 2024, the new regulations of the US Insurance Regulatory Authority (NAIC) have cleared the way for insurance companies to invest in Cfos, eliminating the uncertainty of capital treatment. Jon Godfread, the chairperson of NAIC, pointed out that Cfos have undergone strict cash flow tests and can help insurance companies fulfill their obligations in ways that are difficult to achieve in the public market.
Despite the expansion of the CFO market, some people have doubts about its structure: the underlying assets (such as private equity funds) have poor liquidity and low transparency, and it may be difficult to exit. Economic pressures (high interest rates and slower consumption) have exacerbated the potential risks of underlying assets.
Ludovic Phalippou, a professor at the University of Oxford, believes that Cfos have similarities to Cdos (Collateralized Debt Obligations) before the 2008 financial crisis, namely “cutting and selling opaque assets”.
However, supporters emphasize that Cfos have built-in protection mechanisms, such as the “first-loss equity” portion held by the issuer itself, and the leverage ratio is much lower than that of Cdos in the past. At present, the market size of Cfos is still relatively small, with only about 37.7 billion US dollars rated since 2018.
Recent CFO issuance cases include the $2.4 billion bond of Coller Capital and the products of Neuberger Berman Group. Investors also use Cfos to adjust their private equity exposure. For instance, Thrivent restructured its investment portfolio through Cfos.
NAIC reminds that although Cfos may offer benefits and diversification, it is still necessary to assess risks on a case-by-case basis to avoid hidden dangers.
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