LPC: Managers under pressure as 2015 CLO refinancings loom
NEW YORK, April 28 The most junior investors in US Collateralized Loan Obligation (CLO) funds will try to boost their flagging returns by forcing managers into expensive refinancings. Managers that do not co-operate may have their fees cut or lose control of their funds in the worst case scenario, souces said.
CLOs are the largest holders of US leveraged loans. Equity holders are getting ready to play hardball as their returns have been eroded by a repricing wave that saw a record US$195.8bn of US leveraged loans refinanced in the first quarter alone, according to Thomson Reuters LPC data.
This mass refinancing has led to lower payments to equity investors, which are paid last with the interest left over after senior debt holders are paid and are therefore most exposed to falling costs on the loans that they invest in.
Junior CLO investors’ returns were down 32% in the first quarter, according to Wells Fargo, compared to a year earlier. They are now starting to call for 2015 vintage funds to be refinanced to improve their position as CLO returns come under pressure.
Applying pressure to force a refinancing is something that Tricadia Capital has not used yet but would consider, said Michael Barnes, founder and co-chief investment officer of Tricadia, which invests in and manages CLOs.
“Those levers that can be pulled to create value are going to be utilized,” he said. “You’ll have that additional card you can play at the table.”
Refinancing is expensive for 2015 funds, as they will have to comply with risk-retention rules that require CLOs to keep ‘skin in the game’ and hold 5% of their vehicle’s risk.
A record US$50bn of 2013 and 2014 CLOs were refinanced in the first quarter after a Securities and Exchange Commission (SEC) decision allowed them to refinance without having to pay for risk-retention stakes.
Like most CLOs, 2015 vintage funds typically have two-year non-call periods and are just becoming eligible for refinancing. Some have coupons more than 100bp higher than CLOs that have refinanced, which would flow to equity investors if the deals are refinanced.
UPPER HAND?
Many funds raised in 2015 include provisions that give investors leverage and encourage managers to refinance or face penalties, including losing some of their fees, or even control of their funds.
Oak Hill Advisors and Ares Management have 2015 vintage CLOs that give managers higher fees if they refinance and make their CLO risk-retention compliant, Thomson Reuters LPC reported at that time.
Alcentra and Neuberger Berman also issued funds at that time with provisions that said that management fees would be cut if their deals were not refinanced and made compliant.
Equity holders have the option to push for a refinancing or to call a deal entirely in order to improve their returns, according to Bjarni Torfason, a CLO analyst at Deutsche Bank.
Several options are discussed when CLOs consider refinancing, including cutting management fees to increase payments to equity holders, said David Wishnow, principal at Tetragon Financial Management, which invests in CLO equity.
“You discuss each of these levers and there is a push and pull as you come up with solutions,” he said.
Managers have to hold 5% of their fund under the risk-retention rules, which are part of the Dodd-Frank Act and came into effect on December 24, 2016.
Managers of CLOs that do not currently comply and refinance or reset will be required to hold 5% of each refinanced class, according to Deborah Festa, a partner at law firm Milbank, Tweed, Hadley & McCloy.
Forcing 2015 CLOs to refinance is most likely to succeed on deals where managers have management fee step-down structures, which may range from 5bp to 25bp, according to Jeff Herlyn, a principal at Tetragon. (Reporting by Kristen Haunss; Editing by Tessa Walsh)