February 11, 2002

A $1Mil Carrot For Co-Managers

by: Christopher O’Leary

A recent $797 million stranded utility asset securitization had extremely tight pricing in part because of a deal structure that gave underwriters greater initiative to expand their selling efforts beyond the norm and offered the chance for co-managers to divvy up an additional $1 million bonus based on how well they priced and sold the bonds.

At first glance, the deal seemed like an investor’s nightmare-a first-time issue for a Texas power utility, Central Power and Light Co., securitizing assets it received as part of a state power deregulation agreement, the likes of which have been tarred due to the California energy crisis. What is more, the deal was pricing soon after the fall of Enron Corp., which likely would have been a major player in the just-deregulated Texas energy market if it hadn’t imploded. Finally, the deal’s lead manager, Goldman Sachs, was a marginal player in asset-backed securities, having ranked just fourteenth in global ABS last year.

Yet Goldman and the deal’s co-managers pulled off a pricing coup. Prices on most of the deal’s tranches were substantially tightened, by more than 10 basis points for some tranches, so that the stranded-asset deal priced in the same range as a typical credit-card securitization, which is considered the ABS market’s “gold standard.” The deal’s pricing range was seven to 34 bps, while comparable stranded-asset deals have had ranges of nine to 67 bps.

What appears to be market prestidigitation can be explained quite simply. The deal’s arrangers-issuers CPL Transition Funding LLC (a subsidiary of CPL Co.) and the Public Utility Commission of Texas, along with the latter’s adviser, Saber Partners LLC-put together a unique type of structure that made the deal’s co-managers a much more integral part of the game. It also offered a $1 million bonus pool to be awarded solely at its discretion to the co-managers based on their performance. The result: pricing so tight that future deals from Texas’ deregulation program will likely have a similar carrot-and-stick structure, officials involved with the deal said.

Consider it a reversal of recent fortune. The co-manager slot on a debt financing deal is now generally more political than effectual. Because the lead manager of a deal has become more dominant in how a deal gets allocated and priced, some co-managers wind up essentially serving face time in deals. Also, because of the growing interlinking between lending and debt underwriting, issuers frequently dole out co-manager slots to banks with whom they seek to curry favor, or with which they have done recent business, regardless of such banks’ expertise.

This deal turned all that thinking on its ear. What CPL, the PUC and Saber were after was the best performance possible out of their underwriters. Already, by choosing Goldman as a lead manager, the issuers had a hungry underwriter with something to prove. “Goldman did a great job overall,” said Joseph Fichera, chief executive officer of Saber Partners.

The real meat, however, was reserved for the co-manager roles. Bear, Stearns & Co., Credit Suisse First Boston, Citigroup/Salomon Smith Barney and Merrill Lynch & Co. were all brought into the fold, and given much greater incentive than normal for such a role. First, the issuers split up the deal’s allocation 50/50: Goldman handled 50% of the deal’s allocation, while the four co-managers and Goldman divvied up the remainder, a generous allowance, to say the least.

Also, all the underwriters were competing to win a slice of the $1 million prize. “We would judge their performances; it was completely discretionary based upon the decision of the company, the Commission and us,” said Saber Partners’ Fichera. Top honors for co-managers went to Bear and Merrill.