There has been much focus on CLO refinancings recently, in particular where they concern U.S. risk retention regulation. On Friday the LSTA published a CLO Refinancing and Risk Retention Fact Sheet, which is designed to help market participants navigate the topic.
While CLOs issued before the Dec. 24, 2016 effective date for U.S. risk-retention regulation are grandfathered, many are concerned that any opting to refinance after that date will lose that grandfathered status – although there is much confusion around this point.
In its CLO Refinancing Fact Sheet, the LSTA says that while it is not clear how refinancings will be treated under the new risk-retention rules, it does not believe they should be considered a new securitisation transaction or regarded as a ‘work around’ for retention requirements under Dodd-Frank.
Meanwhile, in its January OnPoint, Dechert outlines the technical reasons why a CLO refinancing might cause the transaction to be caught by the regulation. While Dechert doesn’t believe the relevant agencies intended to subject CLO refinancings to the ‘Final Rule’, the technicalities around what constitutes a securitization transaction mean that a refi where new securities are issued could get caught up in the regulation. So absent any further clarification from the agencies, Dechert believes the market will operate as if a refi will fall within the scope of the Final Rule.
And that is what the market appears to be doing – with time and effort spent looking for ways to solve the potential refi issue. Sources suggest that while the CLO issuer and its investors may not ultimately look to utilise these ‘solutions’, they may be included in a transaction’s documentation to provide the parties involved with options.
The majority have opted to structure transactions with shorter non-call periods to allow for a refinancing to take place ahead of the effective date.
However, the number of managers using this option – this year CVC Credit Partners (Apidos XX), CVP CLO Manager (CVC Cascade CLO-3), and Prudential (Dryden 37) have structured CLOs with a shorter non-call periods, joining the 16 or so from last year – reduces the likelihood of this being a viable option for CLO managers, which would also need CLO liability spreads to tighten significantly to make the refinancing feasible.
The past few weeks have seen an increasing number of transactions price with non-call periods that fall after the effective date – Guggenheim (NZCG Funding), PineBridge (Galaxy XIX), 3i Debt Management US (Jamestown CLO VI), GSO/Blackstone Debt Management (Dorchester Park), and Apollo (ALM XII) – suggesting other options are being used.
Some managers have explored removing the refinancing option altogether in exchange for reducing the AAA coupon, and therefore improving the day-one economics for the equity.
Others still are considering the use of ‘delayed draw notes,’ whereby the notes issued in a refi are included in the original documentation. The solution is understood to have already been used in a U.S. CLO, according to Bloomberg, which reports that Apollo is among those managers that have used the strategy in its ALM XII CLO transaction, while sources say other managers are looking at its potential.
However, as is becoming the norm with more creative solutions to the issue, whether the approach will be deemed to comply with the regulation is being heavily scrutinised and debated.
While it’s not clear how the regulators are going to come down on the regular refinancings – due to the murkiness surrounding the fact no new loans are being securitized, but there are new notes being issued – the delayed-draw option may be considered a cleaner strategy.
“By taking this step and issuing securities before the risk retention effective date, managers are attempting to ensure that no new issuance of securities occurs after the effective date and thus no new securitization takes place after the rules take effect. This simply aligns the legal structure of the transaction with its intent, i.e., merely a re-pricing of selected notes of the original CLO transaction,” says the LSTA. – Sarah Husband
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