Collateralised Fund Obligations are Emerging as a Popular Route to Raise Finance
Collateralised Fund Obligations or CFOs have been around for nearly 25 years, they are a close relative of CDOs (Collateralised Debt Obligations) and are a vehicle for securitising real or alternative assets, including interest in real estate and infrastructure debt and equity, hedge funds, private credit funds, private equity funds. CFOs are basically a form of structured financing especially for diversified private equity or hedge fund portfolios, where several tranches of debt are layered ahead of equity holders. Essentially CFO’s slice and dice private portfolios into bonds, quite often with senior credit ratings from the likes of Standard & Poor,s, Fitch, and Moody’s, and issuers are able to borrow cheaply from an illiquid asset.
Experts suggest that typically CFOs bond issues are worth between 50% and 75% of the value of the holdings in the underlying funds and one of the reasons why the obligation have taken off is that private firms have been looking at ways to source more liquidity. Moreover, dealmaking has been at a low point exacerbated by President Trumps’ tariffs and the turmoil it has created thereby disrupting normal business models. Experts within the rating arena suggest that this market will continue to grow as the rating companies are having more and more CFO’s passing across their desks.
CFOs have become of particular interest to insurance companies and thanks to the NAIC (The National Association of Insurance Commissioners’) the industry regulator, who have allowed industry participants to increase purchases of CFO’s. On 1st January this year the new rules took effect which cleared up any worries or doubts about capital treatment for securities and accordingly has allowed private capital firms to tap into the deep liquidity of the insurance market. The President of the NAIC recently said “Many of these (CFOs) are carefully designed, they are cashflow tested instruments to help insurers to meet their obligations in ways that some low yield public markets can’t”.
From a risk perspective the structure of CFOs have built-in safeguards which will include a “first-loss equity portion” which in the event of a decline in value or default will take the first hit. Furthermore, CFOs unlike vehicles such as CLOs (Collateralised Loan Obligations) who have single issuer risk, (financial troubles for one big borrower can trickle down throughout the market), CFOs have no such similar risk.
Currently there is no available data as to the size of the CFO market but experts suggest the market is relatively small however, in March of this year one bond rating agency advised that since 2018 it had assigned ratings to USD 37.7 Billion worth of CFOs with the bulk of these issues coming since 2022. It is important to point out that CFOs are different to CDOs (Collateralised Debt Obligations) which were mainly responsible for the Global Financial Crisis 2007 – 2009, where subprime mortgages were repackaged, however, with CFOs many of the underlying companies are private equity backed with millions in earnings.
