Last week’s EBA revisions may have dealt a blow to the CLO market, but at this point it doesn’t look to be a mortal one, with players already suggesting there could still be options available for managers seeking to structure and price new vehicles, even those without deep-pocked parents.
As reported, the Capital Requirements Regulation (CRR) effectively removes the flexibility around the definition of sponsor, meaning that the CLO manager as a credit institution or an investment firm has to raise and retain the 5% risk-retention requirement, rather than relying on a third party to provide and retain the equity. This change means that the majority of vehicles that have priced this year, as well as many of those in the pipeline, fall outside of the new guidelines, according to sources.
LCD has tried to piece together the pipeline as it stands post-EBA, but few managers have been willing to comment, which is understandable given the ongoing lack of clarity around the developments.
That CELF Advisors is pressing ahead with its Carlyle Global Market Strategies Euro CLO 2013-1 is encouraging, but perhaps not surprising given it is one of the few managers that remains compliant with the CRR after the revisions. In addition, ICG’s planned €400 million transaction via Lloyds should be unaffected, with the manager raising and retaining its own equity, sources added.
Non-compliant? Proceed as planned
There are many moving parts, and lawyers suggest that managers may still go ahead and price vehicles that are non-compliant with the CRR for several reasons. GoldenTree is said to be continuing with its transaction – a refinancing of an existing European CLO with a third party providing the equity – despite acknowledging that it will be non-compliant, according to sources.
First, non-compliance itself does not come with any express sanctions for those structuring a transaction, although they could be subject to punitive capital requirements, according to a briefing note by Clifford Chance.
And while the initial CLO investors in a vehicle structured according to Article 122a will not face any punitive capital requirements, they will be unlikely to trade out of that vehicle in the future, given that any new investor coming into a non-compliant vehicle will be subject to these penalties.
Also, some suggest that it would be possible to structure a new vehicle with third-party equity and to replace the equity retention provider in due course, though this would be a costly and time-consuming undertaking.
For those wanting to be compliant from the outset, lawyers suggest it may be possible for a third party or affiliate outside of the CLO manager’s regulatory supervisory group to provide the equity as a loan to the CLO manager, but this comes with its own set of expensive tax implications, sources say.
And in the U.S., the LSTA and its working group are in discussions with regulators for alternative CLO structures that will be compliant with the Dodd-Frank Act, whereby the CLO manager would hold 5% of the equity, as well as unfunded Class M notes that replicate and replace the fee stream, sources say. However, risk-retention rules in the U.S. don’t kick in for at least another two years, thus leaving the U.S. CLO market with more time to iron out the details than in Europe.
The following chart shows the pipeline as it stood prior to the EBA’s announcement, but apart from CELF Advisors, ICG, and GoldenTree, it’s unclear which other managers will continue with their pricing efforts.
Total volume in the year to date stands at €1.338 million.
When it comes to the four vehicles that have priced – namely Cairn Capital’s Cairn CLO III, Pramerica’s Dryden XXVII Euro CLO 2013, Apollo’s ALME Loan Funding 2013-1 CLO, and GSO-Blackstone’s Grand Harbour I – sources suggest that Pramerica may be the only one that is compliant with CRR.
Some say that GSO-Blackstone may be compliant on the basis that Mediterranean Bank, as the credit institution, provided the collateral pool and is involved on an ongoing basis, thereby fulfilling the criteria to be the retention provider. However, its compliancy is unconfirmed at this point. Nonetheless, the general consensus in the market is that Cairn Capital and Apollo are not compliant, with the former utilising a third-party investor – the San Bernardino County Employees’ Retirement Association – to retain the 5% equity, while the latter is said to have put the equity in a non-EU insurance subsidiary, according to sources.
In the U.S., the pipeline of CLOs in various stages of the rating process – but for which final ratings have not yet been assigned – increased to $15.42 billion, from $14.88 billion the previous week, according to a report from S&P’s Structured Finance Ratings Group.
S&P expects $33 billion of new vehicles to close based on deals in the pipeline, versus $32 billion the previous week. On the other side of the ledger, optional redemptions for CLOs based on notices received by S&P now stand at roughly $10 billion, unchanged from last week. YTD issuance is $33.3 billion from 59 managers, versus $13.8 billion from 29 managers in the year-ago period. – Staff reports