NEW YORK, Jan 10 (LPC) - The first auction for Collateralized Loan Obligation (CLO) tranches with an embedded repricing feature is scheduled for later this month, a test for the structure that is pitched as a cheaper and faster alternative to a traditional refinancing.
The auction for five tranches of the TCW 2019-1 CLO with Applicable Margin Reset (AMR) technology is scheduled for January 30 with the settlement set for February 18, according to sources.
The AMR CLO structure, which is modeled on auction-rate securities, was developed to allow CLOs to be repriced without running afoul of Dodd-Frank risk-retention requirements that forced managers to hold 5% of their fund.
But after a US Appeals Court in 2018 ruled that CLOs backed by broadly syndicated loans are exempt from the regulation, some managers and investors have stuck with the structure because of the built-in auction process.
The AMR structure is attractive because of “the ease of participation, the transparency and speed of execution and the clear rules (of the process). These improvements may result in increasing the size of the market,” said Olga Chernova, chief investment officer at Sancus Capital Management, who helped to develop the feature. “The structure makes the process more democratic. It is providing financial inclusion to a broader audience.”
There was US$118.7bn of US CLOs arranged in 2019, following a record US$127.7bn in 2018, according to LPC Collateral data. In the last three years, seven funds have been issued, including one reset, with AMR technology, according to auction host KopenTech.
The auction mechanism allows market participants to submit interest rates they are willing to receive for owning the fund’s debt tranches. Offers must be lower than the existing spread. If there is a winning bid that clears the entire tranche and other conditions are met, there would be a tender offer and the notes would be transferred.
The structure was initially developed – and a letter from the Securities and Exchange Commission obtained – to ensure that using the AMR structure would not be considered an offering of new securities and would not trigger risk retention, according to Sean Solis, a partner at law firm Milbank.
If there was a new ‘offer and sale’ of securities as part of a refinancing, it could have forced a manager to provide a new fair-value analysis or buy more equity to comply with the regulation.
The provision continues to be used even after CLOs were exempted from the rule because the AMR structure offers the ability to reprice at a fraction of the cost of a traditional refinancing and in a shorter timeframe, according to Anthony Schexnayder, head of business development at KopenTech.
Neither an investment bank nor a ratings firm needs to be hired for the auction, which cuts expenses. KopenTech says the AMR process may take just 20 days from initiation to settlement.
The structure could also allow more investment firms to bid on CLO tranches they otherwise may not have had access to during the initial sale process.
TCW, which had about US$211bn in assets at the end of September, issued its AMR CLO last year. The fund includes a US$240m Triple A slice with a step-up coupon that increases the interest rate to 149bp over Libor from 144bp one year after closing, which was scheduled for the end of February 2019, LPC previously reported. The tranche includes a second step-up to 154bp two years after closing.
As the fund has just one year left on its reinvestment – a typical new-issue CLO often has a five-year reinvestment period – the auction can seek to cut the spread significantly.
A TCW spokesperson declined to comment.
While just a few AMR CLOs have been issued, market participants say the TCW auction could lead to more funds.
If the first auction “is successful, there would probably be more interest in the AMR structure,” said Peter Hallenbeck, a vice president at Moody’s Investors Service, which has rated AMR CLOs. (Reporting by Kristen Haunss; Editing by Michelle Sierra)