The CLOser - January 2014
The CLOser is Maples and Calder's industry newsletter focused primarily on current Cayman Islands and Irish legal issues relevant to the CLO market. In this edition of the CLOser, we will provide:
(a) a 2013 US and European CLO market review and 2014 predictions;
(b) an analysis of warehousing facilities by our affiliate, Maples Fiduciary ("MaplesFS");
(c) an update on FATCA for Cayman CLO issuers; and
(d) 2013 CLO deal lists.
2013 – A YEAR IN REVIEW1
The US CLO 2.0 market continued its impressive year on year resurgence in 2013 with approximately $82 billion of issuance (more than a 50% increase on 2012 issuance) across 179 CLOs from 91 different managers. Of those, 166 were issued via Cayman Islands registered entities, 12 Delaware and 1 Irish issuer.
There are now over 100 managers who have priced a US CLO 2.0. In 2013, the most active managers were CIFC and GSO, with five deals priced each, closely followed by Ares, Carlyle, CVC, BlueMountain, Columbia, Octagon, Golub and Oak Hill, pricing four deals each. Nearly a quarter of the deals were priced by first time CLO 2.0 managers.
Different arrangers were crowned in each of the first three quarters for most deals priced: Citigroup took Q1, Bank of America Merrill Lynch Q2 and JPMorgan Q3. In Q4 Wells Fargo, Citigroup, JPMorgan and Bank of America Merrill Lynch priced six deals each so the Q4 crown will come down to deal volume for those arrangers.
During 2013 Maples and Calder closed 63% of all US broadly syndicated CLOs.
CLO Equity Funds and Credit Funds
The boom in CLO equity funds and credit funds established to invest specifically in CLO securities continued throughout 2013. Maples and Calder represent a large number of asset managers who have formed such funds, whether regulated hedge funds, closed-ended funds, single investor bespoke funds or managed accounts, and we see a variety of structures and terms.
The credit market media also announced a large number of tie-ins between CLO managers and pension / retirement funds. Tie-ins have significant benefits for the managers who obtain a source of funding for, typically, the first loss on the warehouse and equity in the CLO across multiple deals. Retirement funds have been allocating more to credit investments during 2013, seeking to generate higher investment rates of return and, by partnering with one or more managers, securing control of allocations at the start of a deal. Bespoke manager-tied credit funds may also simplify an investor's internal investment reporting by enabling them to invest in a range of credit securities (primary and secondary markets) and report on the overall fund performance as opposed to line by line individual securities.
Having established a large number of CLO equity funds, credit hedge funds, dedicated PE funds and other opportunistic capital funds in recent years, Maples and Calder is in the process of compiling a CLO fund report on structuring from a Cayman Islands perspective and frequent terms and considerations, for print circulation in Q1 2014.
US Regulatory Issues
US regulatory issues continued to dominate both industry task force discussions and conference seminars during 2013. Amidst the Dodd-Frank risk retention and Volcker Rule discussions, the Cayman Islands also grabbed some of the limelight when, on 29 November 2013, the Cayman Islands government signed a Model 1 intergovernmental agreement (non-reciprocal) with the US relating to FATCA (click here to view our update of 18 December 2013 for further information).
AAA Spreads and Arbitrage
The FDIC change in April 2013 curtailed the appetite of certain US banks and resulted in a scarcity of large triple-A investors. Those still buying could demand better terms and control pricing, resulting in the widening triple-A spreads seen through the second half of 2013. By November 2013, triple-A pricing was around L+148-155. With spreads so wide, Q4 saw an up-tick in buying by established players and, reportedly, some mezzanine and equity investors being encouraged by arrangers to take a portion of the triple-As to see the deals close.
2013 was a good year for the European CLO market. Before February 2013, only two European CLO 2.0s had closed: one in 2009 and one in 2010. Cairn CLO III priced in February 2013 and the drought came to an end. Since that date, 23 European CLOs have priced. Pramerica, GSO and Carlyle each priced two CLOs in 2013. The most active European arrangers were Citigroup followed by Credit Suisse and BCG. Maples and Calder acted on a number of the 2013 European CLOs using Irish issuers and our Irish office has a healthy pipeline for 2014.
During 2013, 200 CLOs (US and European) were listed on the Irish Stock Exchange (Main Securities Market ("MSM") (23.5%) and Global Exchange Market ("GEM") (76.5%)). Maples and Calder's Irish office listed over 56% of all 2013 ISE listed CLOs. Of those 200 listings, 170 were by Cayman Islands' issuers, accounting for 85% of CLO listings (MSM (22%) and GEM (78%)). Maples and Calder's Irish office acted as listing agent on 112 (66%) of the Cayman listed CLOs in 2013.
As is always the case, the start of the New Year brings forth much commentary on predictions for the forthcoming year. CLO issuance volume in 2013 was up nearly $30 billion on 2012 levels, representing a 51% increase year on year. Forecasts for the US market at the start of December suggest the level holding at anywhere from $65 to $80 billion in 2014. Market commentary indicates that pricing will remain around the L+148-150 mark at the start of 2014 with predictions that it will contract later in 2014 to about L+125-135.
Uncertainty over some US regulations, particularly the impact of the Volcker Rule, may temper further increases in 2014, although some market commentary predicts a rush by some managers to build up AUM ahead of the 2016 US risk retention deadline. Likewise, some market participants predict the emergence of CLO 3.0, describing it as a CLO that excludes bonds and other securities to address the Volcker Rule. We are already seeing deals that have not yet priced be amended to exclude bond buckets in the collateral.
Looking at Maples and Calder's warehoused deals alone, the pipeline remains robust and more new managers will enter the market in 2014.
European CLO market predictions are also strong. Forecasts for 2014 range from those suggesting as many as 30 to 40 deals based on prevalence of underlying leveraged loans, whilst other, more cautious predictions, are in the 15 to 20 range, quoting risk retention and the poor arbitrage as inhibiting factors.
WAREHOUSING FACILITIES: A LOOK UNDER THE MaplesFS HOOD
MaplesFS' review of the US market in 2013 clearly demonstrates the recovery of CLO volumes since the credit crisis. As a result, the market has seen a steadily increasing demand for warehousing facilities but, as with other features of CLO 2.0, many of the post crisis warehouse facilities have slight differences to their predecessors. Due to an increased variance in the structuring of warehouse facilities and the fact that MaplesFS works on a broad spectrum of transactions, MaplesFS is often asked for its insight to developments in this area. This section outlines a number of warehousing trends that emerge from an analysis of data across US CDOs and CLOs administered by MaplesFS through the pre and post crisis years to 30 November 2013.
Does MaplesFS have meaningful insight?
As the leading provider of fiduciary services to Cayman structured finance vehicles, MaplesFS believes that an analysis of data and statistics across the entities it administers may highlight significant trends and interesting market information. With a book of business for US CDOs and CLOs (established in Cayman) approaching 60% market share, an analysis of MaplesFS' portfolio should provide some meaningful insight into what the CLO market has been doing and where it is headed. To put this in perspective, for example, in the current year through to the end of November 2013, the aggregate amount of all 2013 warehousing facilities for vehicles administered by MaplesFS was approximately US$30 billion, which represents a significant proportion of the US CLO market.
What proportion of deals are cash managed versus hybrid or synthetic?
Analysing MaplesFS' portfolio based upon deal type (cash managed, synthetic and hybrid) since 2001 when MaplesFS commenced its offering in Cayman, a significant drop off in synthetic transactions since the crisis from around 15% in 2006 and 2007 to less than 2% in the current year, no doubt resulting from changing swap regulations, the post Lehman environment and negative attitudes towards CDOs and synthetics. Conversely, and as you might expect, the percentage of cash managed transactions has increased from 70-75% in the pre-crisis years to over 95% in the last couple of years.
What proportion of deals utilise a warehouse facility?
In 2006 and 2007 approximately 50% of cash managed CDOs / CLOs which MaplesFS administered did not have a warehouse facility. By 2012 over 60% of deals had a warehouse and this trend continued through 2013 as the percentage increased to nearly 70%. Whilst there remain a number of deals this year that did not warehouse, a review of the current year's MaplesFS portfolio to November 2013 suggests that may be due in part to asset pools coming directly from bank balance sheets and from previous deals that are liquidating or refinancing. The data from 2011 (approx. 48% of deals warehoused) and 2012 (over 60%) is a little surprising given the popularity of no warehouse "print and sprint" transactions during that period.
How long on average are warehousing periods?
According to MaplesFS data, the average warehousing period is currently around three months, which is comparable to 2001, and a little shorter than historical durations of about 4.6 months (excluding 2009 and 2010), although recent warehouse durations have, in some cases, exceeded 12 months.
What types of structures are being used in warehouse facilities at the moment?
What is striking from a review of 2013 facilities in MaplesFS deals is how varied the warehouse funding structures are. Participation structures are still popular with arrangers when they are providing the warehouse, as are traditional loan facilities and senior note purchase agreements. For the first loss piece, a mix of preference share, loan and subordinated note funding continue to dominate. It is important to note that in the majority of facilities, a combination of these methods is employed. The use of a TRS facility remains popular amongst certain arrangers. The data also suggests certain arrangers are increasingly standardising warehouse agreements to provide managers with "plug and play" options with respect to the choice of first loss funding.
How many investors are typically involved in the warehouse?
On average, based on a review of the warehouse documents and the initial subordinated securities issued (not accounting for any subsequent trading), MaplesFS observed five or less investors typically involved in CLO warehouse transactions.
How common is a first loss component?
A majority of the MaplesFS administered warehouses for the 2013 sample contained a first loss component. Whilst the more seasoned and larger asset managers tend to have a lower first loss target, new managers, smaller and mid-sized managers are typically required to provide a first loss component of between 20-25% of the overall warehouse funding. The portfolio analysis revealed that the usual method to structure first loss was either through issuance of subordinated notes (over 50%) or preference shares (over 40%).
Why do some warehouse transactions use a merger mechanism?
The TRS and CLO closing merger mechanism became popular following the 2010 amendments to the Companies Law in the Cayman Islands, which brought in legislation to enable one or more foreign entities to merge into a Cayman Islands company using a simplified statutory regime in place of the existing complicated court approved scheme of arrangement.
This technique is still the hallmark of one of the biggest arrangers today and is now utilised by other market participants, including warehouse lenders who step away from the CLO at close. Such warehouse lenders are often required to retain the collateral in a wholly-owned subsidiary for internal regulatory or other reasons, and this structure meets that requirement. The merger gives the arranger the benefit of being able to fund the ramp up of assets in a wholly owned subsidiary during the warehouse period whilst the issuer, through the TRS, takes the exposure to the market value of those assets. On closing, the wholly owned subsidiary merges into the issuer, with the issuer being the sole surviving entity. The arranger receives merger consideration, or consideration for the subsidiary shares, from the proceeds of the issuance of the CLO's securities at close. The advantage of this structure is that the collateral held by the wholly owned subsidiary is vested in the CLO issuer by operation of law, without the need for transfer documentation and without any costly assignment fees for the associated loans.
What are the main warehouse themes that emerge from the analysis of MaplesFS' portfolio for 2012 and 2013 CLOs?
An analysis of MaplesFS' deals suggests that warehousing practices continue to be varied and warehouse structures diverse. The use of warehouse financing for CLOs has continued its upward trend post-credit crisis, with the percentage of CLOs that have warehoused up from just over 60% in 2012 to nearly 70% in 2013. In addition, the average warehouse length has also increased over that period from two to three months. The analysis also highlights a proliferation of first loss investors in the last couple of years. Participants range from traditional manager affiliates to CLO credit and equity funds (established either for the sole purposes of funding the equity in a particular manager's CLO or for investing more broadly in CLO equity), or a combination of both, to new entrants in this space over the past 18 months. Recent new investor types include seed investors (often tying up with specific managers), third party CLO warehouse equity investors and bespoke warehouse equity providers. The average total equity investment in a CLO warehouse is approximately 20-25% of the total warehouse funding, although those percentages vary. The general analysis also highlights the continued development of novel warehouse structures and the introduction of new players in the warehouse space such as non-CLO arranging banks that have stepped in during the past year both to fund the primary warehouse lines for smaller arrangers who might not have their own balance sheets and also to provide additional warehouse funding lines to those provided by traditional arrangers.
Future editions of The CLOser will provide periodic updates from MaplesFS on warehousing and CLO trends, including tracking the size of the warehouse first loss component, length of reinvestment periods and non-call periods, number of deals permitting repricing of the triple-As, reinvestment after the end of the reinvestment period and a review of Make-Whole provisions.
1 Data in this review is derived from a variety of sources, including Structured Credit Investor, Leveraged Loan, CreditFlux, Moody's, S&P and MaplesFS.