Senate hearing opens discussion on BDC regulation changes

A hearing by the Senate banking committee showed bi-partisan agreement for BDCs as a driver of growth for smaller U.S. companies, but exposed some rifts over whether financial companies should benefit from easier regulation.

BDCs are seeking to reform laws, including allowing more leverage of a 2:1 debt-to-equity ratio, up from the current 1:1 limit. They say the increase would be modest compared to existing levels for other lenders, which can reach 15:1 for banks, and the low-20x ratio for hedge funds.

A handful of BDCs are seeking to raise investment limits in financial companies. They argue that the current regulatory framework, dating from the 1980s when Congress created BDCs, fails to reflect the transformation of the U.S. economy, away from manufacturing.

BDCs stress that they are not seeking any government or taxpayer support.

They are also seeking to ease SEC filing requirements, a change that would streamline offering and registration rules, but not diminish investor protections.

Ares Management President Michael Arougheti told the committee members in a hearing on May 19 that although BDCs vary by scope, they largely agree that regulation is outdated and holding back the industry from more lending from a sector of the U.S. economy responsible for much job creation.

“While the BDC industry has been thriving, we are not capitalized well enough to meet the needs of middle market borrowers that we serve. We could grow more to meet these needs,” Arougheti said.

In response to criticism about expansion of investment to financial services companies, the issue of the 30% limit requires further discussion, Arougheti said.

The legislation under discussion is the result of lengthy bi-partisan collaboration and reflects concern about increased financial services investments, resulting in a prohibition on certain investments, including private equity funds, hedge funds and CLOs, Arougheti added.

“There are many financial services companies that have mandates that are consistent with the policy mandates of a BDC,” Arougheti added.

Senator Elizabeth Warren (D-MA) raised the issue of high management fees of BDCs even in the face of poor shareholder returns. Several BDCs have indeed moved to cut fees in order to better align interests of shareholders and BDC management companies.

She said that Ares’ management and incentive fees have soared, at over 35% annually over the past decade, outpacing shareholder returns of 5%, driving institutional investors away from the sector, and leaving behind vulnerable mom-and-pop retail investors. Arougheti countered by saying reinvestment of dividends needed to be taken into account when calculating returns, and said institutional investors account for 50–60% of shareholders.

Warren said raising the limit of financial services investment to 50%, from 30%, diverts money away from small businesses that need it, while BDCs still reap the tax break used to incentivize small business investment.

“A lot of BDCs focus on small business investments and fill a hole in the market. A lot of companies in Massachusetts and across the country get investment money from BDCs,” said Warren.

“If you really want to have more money to invest, why don’t you lower your high fees and offer better returns to your investors? Then you get more money, and you can go invest it in small businesses,” Warren said.

Brett Palmer, President of the Small Business Investor Alliance (SBIA), said the May 19 hearing, the first major legislative action on BDCs in the Senate, was a step toward a bill that could lead to a new law.

“There is broad agreement that BDCs are filling a critical gap in helping middle market and lower middle market companies grow. There is a road map for getting a BDC bill across the finish line, if not this year, then next,” Palmer said, stressing the goal was this year.

Technically, the hearing record is still open. The Senate banking subcommittee for securities and investment could return with further questions to any of the witnesses. Then, senators can decide what the next stop will be, ranging from no action to introduction of a bill.

Pat Toomey (R-PA) brought up the example of Pittsburgh Glass Works, a company that has benefited from a BDC against a backdrop that has seen banks pulling back from lending to smaller companies following the financial crisis, resulting in a declining number of small businesses from 2009 to 2014.

The windshield manufacturer, a portfolio company of Kohlberg & Co., received $410 million in financing, of which $181 million came from Franklin Square BDCs.

“Business development companies have stepped in to fill that void,” Toomey told the committee hearing. “For Pittsburgh Glass, it was the best financing option available to them.”

FS Investment Corp.’s investment portfolio showed a $68 million L+912 (1% floor) first-lien loan due 2021 as of March 31, an SEC filing showed.

Arougheti cited the example of OTG Management, a borrower of Ares Capital. OTG Management won a contract to build out and operate food and beverage concessions at JetBlue’s terminal at New York airport JFK, but was unable to borrow from traditional senior debt lenders or private equity firms due to its limited operating history.

Ares Capital’s investment in OTG Management included a $24.7 million L+725 first-lien loan due 2017 as of March 31, an SEC filing showed. — Abby Latour

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After Downsize, Apollo Prices €357M CLO via Barclays; YTD

Apollo has priced its €357 million ALME Loan Funding V CLO via Barclays Capital, according to market sources. The AAAs are understood to have priced at a 145 bps discount margin.

The transaction is structured as follows:

The transaction was downsized ahead of pricing, amid widespread concern from CLO managers across the market about how tough the collateral-sourcing environment is currently.

For Volcker the transaction will include voting, non-voting, and non-voting exchangeable tranches.

Compliance with European retention regulation is via the sponsor route, with Apollo holding a vertical strip.

The manager priced its previous European transaction in November via Deutsche Bank, and this latest deal marks its fifth European CLO 2.0. — Sarah Husband

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Leveraged Loans: Herbert Park CLO amends transaction as to be Volcker Compliant

Noteholders of GSO/Blackstone’s Herbert Park CLO have been advised that the issuer has amended the transaction documents to enable it to comply with Volcker, by allowing the rated notes to be held in any one of three sub-classes; Collateral Manager (CM) Voting Notes, which will have voting rights with respect to manager removal and replacement, CM Non-Voting Notes, and CM Exchangeable Non-Voting Notes, which will not include voting rights.

The latter class of notes is also exchangeable into CM Voting notes or CM Non-Voting notes. The changes were effective as of May 9.

This follows a similar Volcker-related amendment to Richmond Park CLO.

Both Herbert Park and Richmond Park priced in 2013 ahead of the Volcker Rule coming into effect in 2014.

Last year, ICG sought to Volckerize two of its European CLOs—St. Paul’s II and III—via amendments, while Carlyle amended the AAA tranche on CGMSE 2013-1 CLO and Cairn Volckerized Cairn CLO III via refinancing exercises. — Sarah Husband

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Apollo Prices $474M ALM XIX CLO via Citi; YTD US Issuance: $15.42B

Citi today priced a $473.55 million CLO for Apollo Credit Management, according to market sources.

Pricing details are as follows:

As previously reported, up to 4% of the portfolio can be loans purchased under a price of 50, according to marketing documents. Up to 60% of the loans can also be covenant-lite.

The transaction closes on June 16, with the non-call period ending on Jan. 15, 2019, and the reinvestment period ending on Jan. 15, 2021. The stated maturity is July 15, 2028.

Year-to-date issuance now stands at $15.42 billion from 37 CLOs, according to LCD data. Note that static-pool CLOs are now counted in the volume totals. May volume is $1.28 billion from three transactions. — Andrew Park

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US CLO Issuance Hits 2016 High in April. That’s the Good News …

US CLO issuance

If you’re looking for good news in today’s structured finance market: At $4.8 billion in April, the U.S. CLO market just completed its best month of 2016.

Of course, the April number is less than any month in 2015, when an impressive $97 billion of CLOs were issued (that’s the second-best year ever, behind the $124 billion in 2014). As we’ve reported, analysts have cut expectations for CLO issuance for 2016, what with early-year capital markets headwinds and new CLO-related constraints set to take effect at year-end. – Staff reports

This full version of this story – which includes comprehensive first-quarter leveraged loan market analysis – is available at, LCD’s subscription site offering complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here.

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More CLOs may be called as loan prices rally, cash to equity drops

The recent rally in loan prices has prompted equity investors to start exercising calls on CLOs, with potentially more on the way if the current upswing continues.

So far, two CLO 2.0s have been called this year, both in April. This follows 13 2.0 optional redemptions in 2015 and six in 2014 In total, 10 CLOs have been called this year, following 89 in 2015, 85 in 2014, and 75 in 2013, according to J.P. Morgan.

This year’s called 2.0 transactions are the Mill Creek CLO from 40/86 Advisors and Babson 2011-I, both of which were originally issued in 2011.

When looking at the factors that increase the likelihood of a call, analysts at Nomura determined that higher equity net asset values (NAVs), higher costs of funding, and lower cash flows to the equity increase the likelihood that a CLO gets called. Analysts at J.P. Morgan also cited the equity purchase price, loan sourcing conditions, and the type of investor holding the equity are additional factors.

The Mill Creek CLO, which is 15 months past its reinvestment period, saw average quarterly payments to its equity over the past few years of under 3%, well below the average CLO 2.0. Its most recent equity NAV was about 48% though, which is in the 82nd percentile across all 2.0s, according to data from Nomura analysts.

The Babson 2011-I, which is 19 months past its reinvestment period, similarly saw its average quarterly distributions to the equity fall to 2.9%, from 5%, while its NAV was around 44%, which is within the top quarter of CLO 2.0s.

Looking ahead, Nomura analysts see another nine CLO 2.0s past their reinvestment periods that are candidates for an optional call since their quarterly equity distributions have fallen by 1.2% or more and their equity NAVs are above 36%.

Analysts at J.P. Morgan believe that a sustained rally in loan prices could lead to more CLO 2.0s getting called since the call also provides an exit for some of the equity that has exchanged hands over the past few months.

The entire CLO 1.0 universe is otherwise past its non-call and reinvestment periods at this point. The 2006 vintages were over half of the total CLO 1.0s called last year followed by the 2007 vintage. Over the next few years, J.P. Morgan analysts anticipate that the 2007 vintage will take over as the most actively called. Typically CLO 1.0s that were called in 2015 had 32% of the original transaction size outstanding and were about three years past the end of their reinvestment periods.

The same goes for Europe
In Europe too, some expect improved secondary loan market prices to trigger more CLO redemptions. In its April 8 European Asset-Backed Barometer, Deutsche Bank Markets Research suggested several other deals issued in late 2005/2006 that may become economical to call, including Wood Street II (Alcentra), Green Park 2006-1 (Blackstone), Boyne Valley CLO (via AIB Capital Markets), and Theseus 2006-1 (Invesco).

There has been a marked increase in loan BWIC activity in both the U.S. and European secondary loan markets in recent weeks, some of which may related to CLO redemptions, sources said. Through April 8, 14 European BWICs totaling €744 million have been put up for sale, versus €1.2 billion from nine BWICs in the same period last year, according to LCD data. That’s a 56% increase in deal count over last year, although the volume figure trails by 40%. Meanwhile, in the U.S., there has been a flurry of BWIC and OWIC activity as well, with the amount of loans put up for sale via BWICs through April 8 standing at $5.5 billion, up from $1.6 billion in the year-ago period. CLO 1.0 redemptions have driven these portfolio sales.

Three European CLOs have been called so far in 2016, including BNPP IP’s Leveraged Finance Europe Capital IV, Versailles CLO M.E.I, and Dalradian European CLO IV. In 2015, LCD tracked 28 call notices, with 26 issued by CLO 1.0 transactions and two by CLO 2.0s. The most recent European CLO BWIC was for a pending CLO redemption from a large, established manager. — Andrew Park/Sarah Husband


Assets at US Leveraged Loan Funds Grow for First Time Since July

loan fund assets under management

With leveraged loan prices surging in the secondary market in March, loan mutual funds’ assets under management grew by $2.54 billion during the month, to $109.64 billion, according to S&P Global Market Intelligence LCD.

This is the first time that loan fund assets under management have grown since July 2015, and it’s the largest increase since February 2014.

That being said, essentially all of March’s increase can be attributed to secondary market gains, rather than a groundswell of interest in the asset class from retail investors. – Kerry Kantin

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JPM Survey Finds Growing Investor Interest in CLO Mezzanine Debt

A recent survey by analysts at J.P. Morgan found that investors see the best relative value in the mezzanine tranches of CLOs, especially when compared to other asset classes.

In a poll of 110 of the firm’s clients, almost 70% of respondents saw the best relative value in CLOs when compared to other asset classes such as commercial mortgage-backed securities (CMBS), high-yield loans, asset-backed securities (ABS), high-yield bonds, and residential mortgage-backed securities (RMBS). None of those other asset classes had more than 15% of respondents saying they saw the greatest relative value in those areas.

Within CLOs, respondents expressed the greatest interest in picking up BBBs, BBs, and equity in the secondary. About 15 saw the best relative value in BBBs, more than 25 in BBs. This marks a shift in sentiment from the first quarter when only two investors saw the greatest value in BBBs and about 12 in BBs. More than 40 investors indicated they plan to add more CLO mezz or subordinated debt to their holdings over the next six months, greater than any other quarter going back to the third quarter of 2014.

Investor concerns outside of the energy and commodities names seem to primarily be focused on the retail sector as about 50 respondents expressed the greatest concerns there,  more than triple the number who were most concerned about healthcare or technology. Retail names make up about 6.7% of the collateral in CLO 2.0s.

Of the 110 respondents, nearly half came from insurance and money management firms, which analysts believe reflect the makeup of the broader CLO investor base. Hedge fund investors were the second largest respondents following money managers. — Andrew Park

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Young Exits Och-Ziff to Co-Found New Alternative Asset Manager

Don Young has left his position as managing director at Och-Ziff Capital Management to establish a new asset management firm, according to market sources.

Young will join forces with Mike Damaso and Jay Garrett as co-founders of the new firm, which will be a diversified alternative asset manager (including CLOs), and which is expected to launch later this year, according to market sources.

Eldridge Industries is a key investor in the new firm. Eldridge also acts as a holdco for Security Benefit.

Young has worked at Och-Ziff since September 2013, and previously has held positions at Octagon Credit Investors and Primus Asset Management. Damaso was previously chairman of the investment committee overseeing corporate credit investing and a portfolio manager for the NZC Guggenheim Fund. Garrett was previously at Matlin Paterson. — Sarah Husband

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US CLO Issuance Rises to $4.2B in March as Market Steps Cautiously

US CLO issuance

U.S. CLO issuance picked up to $4.2 billion in March from $2.07 billion in February and from a paltry $827 million in January, according to S&P Global Market Intelligence LCD.

While the March number is far inside 2015’s monthly average of $8.16 billion, it shows that the CLO trade is not dead yet. Year to date U.S. collateralized loan obligation issuance stands at $7.1 billion, compared to $30.8 billion in activity at this point in 2015.

Obviously, 2016 issuance will not match last year’s $98 billion, which was the second-most on record, behind the $124 billion in 2014. In fact, a host of CLO analysts revised lower their already-tempered 2016 full-year volume predictions after the market’s tepid start in January. The consensus now calls for roughly $55 billion in issuance this year. – Staff reports

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