The CLOser is the Maples Group's industry newsletter for the global CLO market.
The Maples Group global CLO team provides Cayman Islands and Irish legal advice and CLO issuer / co-issuer and fiduciary services in the Cayman Islands, Delaware, Dublin, Jersey, London and the Netherlands.
This edition of The CLOser includes1:
- US and European CLO Market Reviews
- Investors Warm to Evolution of CRE CLOs
- Global Listings Update
- Cayman Islands Vehicles - Which Form to Choose?
- Your Global CLO Team - A CLOser Look
Calling All CLO Managers
- Bonds are Back on Your Bucket List
On 30 January 2020, the Federal Reserve, SEC and three other regulatory agencies published a re-proposal to the covered funds definition to Section 13 of the Bank Holding Company Act, also known as the Volcker Rule.
Proposed changes to the definitions of "loan securitization" and "ownership interest", if adopted, would allow a return of the 5% bond bucket for US CLOs.
Under the current regime, US banks are barred from keeping an "ownership interest" in a "covered fund." "Ownership interest" is broadly defined and includes not just the subordinated debt / equity of a transaction, but the most senior tranche (the AAA tranche) because that class of notes typically holds a right to remove the manager for cause. "Loan securitizations" are excluded from the definition of a "covered fund" therefore US banks have been able to invest in CLOs where the portfolio comprises only loans and short term cash equivalents (i.e. not bonds).
If the proposed changes are adopted, the "loan securitization" definition will be expanded to permit the acquisition and holding of up to 5% nonloan assets, such as bonds. Furthermore, senior debt tranches that bear certain hallmarks which are set out in the re-proposal will be able to take advantage of a 'safe harbour' from the definition of "ownership interest", even if such notes carry the right to remove the manager for cause. AAA CLO notes typically bear such hallmarks.
If the proposed changes are implemented, a number of existing US CLOs have a springing bond bucket concept hard wired into the deal documentation. Existing CLOs that do not have that but who would want to take advantage of such regulatory changes would need to execute amendments after obtaining the requisite consents.
The proposal is subject to a 60-day comment period but the market expectation is that the proposals will be adopted.
US CLO Market Review
2019 In Review
Despite unease about global macroeconomic conditions, primary CLO issuance in 2019 was a solid US$118 billion, which exceeded expectations and shows the product as remarkably robust considering that 2018 was a record CLO 2.0 year at US$128 billion. However, limited refinancing / reset activity (US$46 billion compared to US$122 billion in 2018) meant that overall market activity was slower paced. The number of priced new-issue deals (246) was an increase of five deals on 2018 and nine BSL managers launched their first post-crisis BSL CLOs: AGL CLO Credit Management, Birch Grove Capital, East West Investment Management, Elmwood Asset Management, Fort Washington Investment Advisors, Goldman Sachs Asset Management, Halsey Point Asset Management, Morgan Stanley Investment Management and Whitebox Capital Management. Meanwhile in the middle market, Audax Management Company, FS KKR Capital, Pennant Park and Owl Rock Capital also debuted.
Below is a snapshot of highlights in 20192 :
- US$118 billion from 246 deals in 2019 compared to US$128 billion from 241 deals in 2018.
- Refi and reset activity accounted for another US$46 billion in issuance from 93 CLOs.
- 13 new CLO managers (BSL and MM).
- While several BSL managers priced five CLOs, CIFC and Octagon managed to lead the pack, each pricing six CLOs.
At Dana Point in December 2019, there was an expectation that 2020 CLO primary issuance would be down about 20% on 2019 levels. Several managers indicated they would be looking to push their 2020 deals through before the November US presidential election and ideally ahead of a possible rush (with consequential excess supply) as election day approaches. The year has indeed started at a steady and reasonable pace with some managers putting two or more warehouses in place for the year in January. Bank predictions are that the new-issue market will not exceed US$100 billion (BAML and Barclays US$80-90 billion, Morgan Stanley US$75 billion, Wells Fargo US$90 billion) and general expectation of US$30-50 billion in refi / resets.
That being said, refi / reset activity is off to an exceptionally strong start in January. Market conditions and CLO vintage are once again more aligned and dozens of new cleansing notices have been issued with managers looking to press ahead with one or more refinances and resets on tight timeframes. We are aware of in excess of 30 transactions looking to refi at this point in time.
The first CLO incorporating applicable margin reset ("AMR") provisions in the transaction documents, TCW CLO 2019-1 AMR, Ltd., utilised Kopentech's digital platform to refinance five debt tranches through an auction process on 30 January 2020. The AAAs, which were capped at 115bps for the auction, priced at 107bps and overall the weighted average cost of capital was reduced by 43bps. While the auction process was declared a success by those involved, there are some concerns about operational aspects and the slight premium paid by investors to encourage the brokerdealers to participate.
Turning to a trend we expect to see much more of in the coming decade, the environmental, social and governance ("ESG") movement is worth mentioning. While the European market was the first to close a CLO with ESG criteria embedded in the asset eligibility criteria in March 2018 (Providus CLO I, managed by Permira Debt Managers), it more recently closed a fully ESG-compliant CLO (North Westerly VI via NIBC Bank). With eyes focussed on Australia's fires, Greenland and Antarctica's melting icecaps and heightened concerns about the planet and social issues, Blackrock told its clients in January that it intended to take a stronger stance on climate change by exiting investments in thermal coal, noting that climate risk is an investment risk that will impact the long-term performance of portfolios.
In December 2019, the new EU Disclosure Regulation EU/2019/2088 on disclosures to be made by asset managers and investment funds relating to sustainable investments and sustainability risks came into force as part of a process to put into effect the European Commission's Action Plan for Sustainable Finance which sets out the EU strategy to integrate ESG considerations into its financial policy framework and mobilise finance for sustainable growth. For more information on the regulation, see here3 .
With an uptick in ESG ETFs and other investment products, we fully expect to see the ESG movement gain significant momentum with the result that ESG provisions will likely be incorporated into US CLOs in the near future. The start of a new decade brings time for reflection and looking forward. 2020 is a good time to start embracing socially responsible investing.
We fully expect to see ESG provisions being incorporated into US CLOs
Ending on what promises to be a positive note and what may spur higher issuance levels in 2020, the Federal Reserve has announced that it proposes to change the covered funds definition in the Volcker Rule which should hopefully mean the return of the 5% bond buckets in US CLOs.
Notwithstanding the upcoming US presidential election in November, we anticipate another successful and stable year for the US CLO market and we look forward to continuing our partnership with our friends and colleagues in the CLO industry.
Download >> The CLOser - February 2020
1 Data in this publication is derived from a variety of sources, including the Maples Group, Structured Credit Investor, LCD, Leveraged Loan, Creditflux, Moody's, S&P, Fitch, Irish Stock Exchange and Central Bank of Ireland.
2 Sourced from LCD, Wells Fargo reports, Creditflux and Structured Credit Investor.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.