NEW YORK, Aug 25 (Reuters) - Collateralized loan obligation (CLO) managers may look to extend the life of more than US$250bn of deals eligible to refinance before rules take effect in December that require firms to hold onto a portion of their fund’s risk, which may make the creation of new funds harder.
When risk-retention rules go into effect, some firms, which typically sell their CLO debt tranches to outside investors, may not have the capital to purchase and hold the required portion of their fund. The upcoming rules are cited as one reason CLO issuance is down 49% this year with just US$37bn of CLOs arranged, according to Thomson Reuters LPC Collateral data.
CLO managers have refinanced US$5.6bn of CLOs this year through August 24, according to Wells Fargo data, with more expected this year. Among those are three so-called resets, which allow managers to keep their current deals in place longer, giving them more time to invest in new loans, and preserving their revenue stream. Firms that refinance after the December 24 effective date, will, in many cases, have to comply with risk-retention rules that require a firm to hold onto 5% of their fund.
“It will be difficult to implement a refinancing after December when risk retention takes effect, so in the coming months there is incentive to refinance or reset a deal,” said Bjarni Torfason, a CLO analyst at Deutsche Bank.
Carlyle Group this month reset its 2012-3 CLO, extending the reinvestment period and maturity, which will allow the deal to stay in place longer, according to sources. In March, American Money Management also reset a fund. There are currently additional resets in the works, sources said.
In a CLO reset, similar to a loan amend-and-extend, the original deal, including the loans it owns, remains in place and its reinvestment period or maturity is extended to allow the deal to remain outstanding longer. CLOs typically have a four-year reinvestment and once that timeframe is up, there may be restrictions on buying new loans. Extending this period allows the fund to purchase new loans for a longer period of time. In a refinancing, the tenor of the vehicle remains the same while the interest rate paid to investors may be cut.
“Resets are a great development for the market,” said Tom Majewski, founder of Eagle Point Credit Management, which invests in CLOs. “They help debt investors get paid back at par, and give equity investors the ability to keep a deal that is going well in place longer. For the manager, [a reset] allows it to extend its assets under management without ramping a new portfolio.”
Demand for CLO liabilities has increased and sometimes that demand will be for shorter-dated paper, which may allow for a refinancing to improve the cost of capital, said Justin Plouffe, a managing director at Carlyle Group focused on structured credit investments. Sometimes there is demand for longer-dated paper, which may mean a reset makes the most sense to allow a fund more time to invest. That decision is determined after conversations between the manager, arranger and equity investors, he said.
“One benefit of the reset is that you don’t have to go through the liquidation of a portfolio that is perfectly fine and then go through the process of ramping up a new one,” said Torfason.
With loan volume down 16% in the first half of the year compared to the same time period in 2015, according to LPC, a reset also eliminates a manger’s need to find collateral to raise a new CLO. There was US$146.6bn of institutional loan issuance in the first six months of 2016, down from US$173.6bn during the first half of last year.
“The availability of loans impacts your thoughts on doing new-issue transactions,” Plouffe said. “The lack of new issuance generally, and specifically this time of year, makes it more attractive to do a reset or a refi because your assessment of what’s best for the deal focuses a bit less on the asset side.”
In the fourth quarter of 2016, more than US$250bn of US CLOs, or 72% of outstanding post-crisis deals, will have exited their non-call period and be eligible to refinance, according to an August 19 Wells Fargo report. This means there are a lot more opportunities for additional resets before the end of the year.
Apollo Global Management last year kicked off the recent CLO reset phase with the reset of ALM VI, according to LPC data. There were six resets in 2015, according to Wells Fargo data.
The Carlyle reset with Citigroup extended the maturity and reinvestment period of the CLO, with some new and some existing investors, sources said. American Money reset its AMMC CLO IX, also with Citigroup, extending the reinvestment period of its deal to 2018 from 2016, sources said.
CLOs, which pool loans of different credit quality, sell slices of the fund of varying seniority, from Triple A to B. Cutting the rate paid to senior investors through a refinancing increases payments to holders of the equity, the most junior and riskiest part of a CLO, who are paid last after the fund’s bondholders.
Spokespeople for Apollo, American Money and Citigroup all declined to comment. (Reporting by Kristen Haunss; Editing by Michelle Sierra and Jon Methven)