The return of CFOs

Temasek’s recent bond issuance is a sign the market is once again receptive to securitisation deals for private equity portfolios.

Temasek’s recent bond issuance is a sign the market is once again receptive to securitisation deals for private equity portfolios.

When we wrote about Temasek’s recent issuance of $510 million in listed bonds, we mentioned it was oversubscribed by more than eight times. That means the Singaporean state-owned investment firm could have extracted $4 billion in liquidity from the partial sale of its $1.1 billion portfolio, something that should make players in the secondaries market sit up and take notice.

If you haven’t read our analysis on Temasek’s Astrea III initiatives (and we highly recommend you do), public securitisation of private equity portfolios, or collateralised fund obligations (CFOs), are considered a part of the secondaries market because they allow equity holders to extract liquidity from their portfolio by transferring assets into a special purpose vehicle, similar to a partial sale.

CFOs don’t suit all private equity managers. You need a sufficiently diversified portfolio, something not all managers will have. Not only this, it’s helpful to be a big player. “I don’t know what Temasek’s credit rating is but I assume it’s better than that of a fund of funds,” one of my sources quipped.

Securitising a portfolio can have particular advantages over a straight secondaries sale, market insiders say. “The upside can be partially retained, depending on the share of equity and junior securities sold to new investors,” Montana Capital Partners’ Christian Diller and Marco Wulff explained previously in a guest commentary. “The sponsor can maintain its existing GP relationships, keep know-how in-house, and continue to gain valuable information from its ongoing involvement with the portfolio.”

Of course, CFOs aren’t a new phenomenon – the first such deal closed in 2001 by Prime Edge Capital, a fund of funds vehicle managed by Capital Dynamics, and as many as a dozen deals closed before the 2008 global financial crisis. When collateralised debt obligations, fuelled by sub-prime mortgage loans, derailed global markets in the worst financial crisis since the Great Depression, CFOs largely disappeared.

Post-crisis, only a handful of such deals have closed, but sources say this transaction should pave the way for future issuances in a meaningful way.

And meaningful they are: “What this does is it converts a very illiquid asset class into tranches that segregates risk/return profiles and converts variable cashflows into fixed income securities,” Pablo Calo, a managing director at Park Hill/PJT Partners, the financial and structuring advisor on the Temasek deal, told me. Such structures open up private equity to a much wider investor base, benefiting the holder of the equity, the investor base and the industry as a whole.

“Imagine if you and I could start buying exposure to private equity in small pieces and through simpler structures, then suddenly the potential investor base grows significantly,” Calo said.

One type of investor that is well suited to issue such deals is insurance firms, particularly in the US. CFOs are also a natural fit for such firms and other regulated investors who want to reduce their risk-weighted assets, Park Hill’s head of secondaries advisory, Larry Thuet, told me.

While it’s not likely we’ll see a sudden explosion in such deals, Temasek’s successful issuance is a sign the market is again hungry for safe exposure to private equity – a good thing for players looking at securitisation over a straight secondaries sale.

How long will it take for securitisation in private equity to really kick off? Get in