The $84 billion new-issue U.S. CLO market continues to find innovative ways to evolve and increase efficiency, and one of the latest developments entails a refinancing mechanism that skips the typical process of – and not inconsiderable cost associated with – issuing a new set of notes with lower coupons.
This method, known as the applicable margin reset (AMR), debuted in June on a CLO from Crescent Capital. It was developed by alternative asset manager Sancus Capital, which was the equityholder on that transaction.
Sancus was able to receive a no-action letter from the SEC on Sept. 1, 2016, opening the structure up to other interested CLO managers. Already a few are planning to use the AMR in upcoming new issues, as well as resets, though for now the structure is expected to be more of a one-off until investors and managers become more comfortable with it, sources said.
One-off or no, the timing of this development in the CLO market – the dominant investor in what is now the $947 billion U.S. leveraged loan market – coincides with a veritable flood of CLO refinancings over the past few quarters, as equity investors revisit these vehicles in an effort to lower costs amid intense demand in the institutional investor market.
CLOs are special-purpose vehicles set up to hold and manage pools of leveraged loans.
One way the AMR address that specifically: Equity investors might be able to bypass refinancing expenses that can total some $700,000 per transaction, sources said. Those fees can add up for CLO arrangers, in a big way. So far in 2017 there have been a record 207 refinancings totaling $90.6 billion, according to LCD.
How AMRs work
Under the AMR, at specified dates after the non-call period, an auction service provider, which in Crescent’s instance was Starling Software LLC, receives bids from broker-dealers on behalf of investors to determine the new coupon on the notes in lieu of a refinancing.
The coupon will not change unless the auction service provider receives bids that total the entire size of the tranches (excluding those that must be held for risk retention purposes).
Upon successful completion of the process, existing notes will be transferred at par plus accrued interest from the existing holders to the winning bidders at the new levels.
The AMR differs from a typical repricing because the AMR can either be triggered by majority equity holders or occur automatically at specified dates, as opposed to a repricing, which must be initiated by the CLO manager or equityholders, lawyers at Dechert wrote in September 2016.
To prevent an exchange from taking a CLO out of compliance with risk retention, a retention holder of a vertical slice would submit what’s known as a “retention order” to exclude the notes they hold from the AMR to ensure they maintain the required 5%. The retention holder will still have the coupons on its notes reset if the AMR process is ultimately successful.
The widespread adoption of the AMR could potentially further broaden the base of CLO investors.
While large allocations of new-issue tranches often go to some of the most active accounts, the process of a reverse dutch auction opens the refinanced tranches up to any investor that submits a bid through a dealer, sources said.
The AMR could also bring greater transparency to the market, as submitted bids will be publicly available following the auction, though the names of the bidders will remain anonymous.
Clearly, the CLO market has recognized that there is value in the refinancing option, in an effort to take advantage of compressing spreads amid 2017’s record volume of loan repricings.
A number of debtholders, however, have expressed reservations about the development of an easier process for receiving lower coupon payments or possibly being taken out of the paper following the AMR.
In order to placate those concerns, features such as a make-whole provision, longer non-call periods, threshold or reserve margin rates, limits on when the next AMR will be held, and shorter re-investment periods are being offered.
“If anything, a combination of a make-whole provision and shorter reinvestment periods may benefit debt investors more than equity as it offers [the debt] protection initially,” a CLO investor said.
Given the novelty of the structure, though, equity investors may find that such concessions are worthwhile for now, as it’s more important to get debt investors comfortable investing in CLOs featuring the AMR. If anything, further modifications can be expected in the future, based on the feedback from both investors and managers. — Andrew Park
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