LONDON May 23 High investor demand for scarce
US leveraged loans is forcing managers of new Collateralised
Loan Obligation (CLO) funds to include delayed draw tranches to
buy time to build up leveraged loan portfolios and keep the
issuance of new CLO funds on track.
Three recently-priced CLOs have delayed draw tranches,
including Carlyle Group's Carlyle Global Market
Strategies 2013-2 CLO. The fund's highest rated paper includes
$352.5 million of AAA notes and $35 million of delayed draw
Delayed draw tranches help managers to avoid paying full
liability costs until CLOs are fully invested.
Carlyle has six months to borrow the $35 million tranche
before the spread rises to 115 basis points (bp) and investors
will be paid a 57.5bp commitment fee while the funds are
Buying US leveraged loans is becoming increasingly difficult
due to thin supply and insatiable demand. More than $34 billion
of new CLO money and $24 billion from retail mutual funds has
poured into the market since the start of the year and is
competing for assets.
CLO managers are buying time to put complete loan portfolios
in place. Equity returns can suffer if funds are issued without
full income-producing loan portfolios in place as they start to
incur liability costs immediately after closing.
Although $262 billion of new leveraged loans were priced
through April, only $58 billion was new loans, according to
Thomson Reuters LPC data, which has left CLO managers short of
new loan collateral.
CLO managers are being forced to pay up to buy new loans in
the secondary market. Average bids on the top 100 most liquid
leveraged loans recently hit multi-year highs of 100.57
according to Thomson Reuters SMi100 index.
"Strong loan demand has pushed up secondary loan prices and
contracted spreads," said Maggie Wang, senior structured credit
research analyst at JP Morgan.
"Delayed-draw tranches can improve CLO deal economics for
equity holders by providing managers with additional time to
acquire loans at a discount and optimise leverage in the deal,"
Shenkman Capital and Neuberger Berman followed Carlyle's
lead by adding delayed-draw tranches on their new CLOs.
Investors in Shenkman's Brookside CLO subscribed to a $40
million delayed-draw tranche, and Neuberger placed a $35 million
Delayed-draw tranches rely upon finding higher-rated
investors, which could curb uptake of the feature, as
lower-rated buyers could have to post collateral to buy the
"While the delayed-draw tranche is very helpful for CLOs
facing a longer ramp-up period, there is a limited universe of
investors who can participate," said Eric Moser, a partner in
the Alternative Investments practice at Milbank, Tweed, Hadley &
Carlyle's delayed-draw note holders have to maintain an S&P
credit rating of at least A-1. High ratings offset counterparty
risk and the likelihood of creditors having problems funding
Delayed-draw tranches were seen in the last CLO boom before
the collapse of Lehman Brothers in 2008, but the feature is now
favoured by smaller managers that lack the balance sheet scale
to build loan portfolios quickly.
"Using delayed-draw tranches can alleviate some of the
pressure on managers concerned about receiving favorable loan
allocations in the new issue market" said Neil Weidner, a
partner who specialises in securitization and structured finance
at Cadwalader, Wickersham & Taft LLP.
"I think you are going to see more managers attempt to take
advantage of the delayed-draw feature in the second half of the
year as managers respond to the competitive environment for loan
assets." he added.