Crescent Capital’s latest collateralised loan obligation (CLO) includes an embedded automatic refinancing feature, which is expected to make such future transactions cheaper and faster.
The deal could prove a significant development in the context of heightened risk retention requirements in the asset-backed securities (ABS) market. According to a person close to the deal, the AMR structure provides a cheaper, more efficient mechanism by which the deal parties can reset margin rates on different tranches of the CLO in an effort to avoid the costly and time-consuming refinancing process.
The $413.7 million Atlas Fund, which closed at the end of July, comes with a built-in automatic margin reset (AMR) feature. It’s based on a mechanism which means that each class of debt is subject to auction after the mandatory two-year non-call period.
|
|
"The AMR cuts through all that the net effect of which is to make the refinancing cheaper and more efficient" |
|
|
While the CLO fund itself is standard, with four or five tranches of debt and one equity tranche, the built-in AMR is a first, according to Dechert partner Sean Solis, who helped design the feature. In order to refinance, the CLO manager has to create a new offering memorandum and update valuation analyses if they are complying horizontally. In each case, it will also have to reassess all aspects of risk retention given such a refinancing is a new issuance of securities.
“The AMR cuts through all that the net effect of which is to make the refinancing exercise cheaper and more efficient,” he said. “This directly benefits equity investors and potentially provides increased access and liquidity to the debt investor community.”
The Securities and Exchange Commission confirmed in a September 2016 no-action letter that the use of an AMR would not trigger risk retention requirements, meaning it didn’t qualify as a new offer and sale of ABS. This solved some problems down the line, according to Solis.
A refinancing is treated like a new sale and subsequent offer of securities, and regulated as such when it comes to prospectuses and valuations.
The addition of an AMR could make refinancings more attractive to CLO managers and sponsors, and more interesting for the junior tranche investors, which get paid after all the senior debtholders have received their interest. By re-pricing some of the most senior tranches of debt, equity holders could see their own payments increase.
Olga Chernova, founder and chief investment officer of Sancus Capital Management, which acted as CLO equity buyer, said the traditional refinancing process in CLOs had many issues. These were solved through the use of an AMR, which was two years in the making.
AMR CLOs operate in a similar way to auction-rate securities, with investors submitting offers of coupons they would like to receive in exchange for buying into the CLO’s debt. Their offers must be lower than existing rates - if no bids are low enough or if there are no bids at all, CLO tranche spreads continue with existing terms. The bids were required to come in at least 10% lower than existing spreads to be valid, Asif Khan, head of CLO origination at MUFG Securities Americas, which acted as lead arranger, told Bloomberg.
The volume of CLOs has dropped significantly in the past two years, after the Dodd-Frank Act introduced new rules forcing managers to hold at least five prevent in their fund. The new so-called risk retention principle may have caused the $900 billion CLO market to stagnate but has forced CLOs managers to look into more creative ways of financing. IFLR covered in July a transaction that is believed to be one of the first where a third-party source of equity investment supported a global CLO business.
CLO reworks, however, have been on the rise. Data from Thomson Reuters LPC Collateral estimates that $100 billion of CLOs were refinanced in 2016.
“This first deal was challenging because we had to memorialise the AMR mechanics, which required significant time and care,” said Solis. “But given there is now precedent for this in the market I expect more clos to take up the feature in future offerings.”
STRUCTURE OVERVIEW |
|
ASSET TYPES/TRANCHES |
|
Tear sheet
Crescent Capital acted as collateral manager, while Sancus Capital Management was CLO control equity buyer. The AMR was designed by Sancus and Dechert. MUFG Securities was lead arranger on the new fund. BNY Mellon was appointed trustee, collateral administrator, paying agent, registrar on the CLO.
IFLR1000’s Deal Data can be found here
See also
Merit of risk retention rules in the spotlight
STS agreement good for EU securitisation