Buying Time

Non-investment grade corporate loans are in high demand, but financing to warehouse them for deals is scarce, so CLO managers are reaching into their tool boxes for something that hasn’t been used much since the financial crisis: delayed-draw funding.

Collateralized loan obligations issue bonds and use the proceeds to purchase a portfolio of noninvestment grade corporate loans. Managers want to acquire the collateral as quickly as possible in order to avoid paying interest on the bonds before they can collect interest on the loans.

There are several ways to address this problem. Prior to 2007, it was fairly easy to obtain a line of credit from a bank to warehouse the loans to be securitized. But these days few financial institutions are willing to tie up their balance sheets with warehouse funding.

Another strategy is to “print and sprint,” that is to issue bonds and quickly acquire existing loans in the secondary market. This was a common practice last year. But money has been pouring into the loan market from all quarters, bidding up secondary prices to levels that reduce the potential for arbitrage – although loan prices have come down from their highs amid the recent turmoil in the broader credit markets.

This means that CLO managers must often wait to buy new loans when they are issued, which takes much longer. To minimize the negative carry, some managers are using a third strategy: They are structuring deals that fund at a future date.

In June, American Money Management Corp. closed on a term funding facility with an initial investment of $30 million from equity holders and an unfunded class A of delayed draw notes. Over the next two years, noteholders may advance funds to the manager in $5 million increments up to $240 million, according to a presale report published by Fitch Ratings.

In May, WhiteHorse Capital closed on a similar facility with an initial investment of $25 million from equity holders and $141 million class A of delayed draw notes, according to Fitch.

And in March, Valcour Capital Management closed on a term facility with an initial investment and delayed draw tranche of the same size, according to Fitch.

The Royal Bank of Scotland was the lead manager on all three deals.

There have also been a handful of CLOs in which the majority of the senior tranches fund immediately, but a single, smaller tranche funds at a later date. In March, the Carlyle Group issued Carlyle Global Market Strategies CLO 2013-2, which includes a $352.5 million tranche of ‘AAA’-rated notes that funded at closing and $35 million of ‘AAA’-rated delayed draw notes, according to rating agency presale reports. Noteholders receive interest only on the drawn portion of the notes and are entitled to a commitment fee of 0.575% on the undrawn portion, according to a presale report published by Standard & Poor’s.

At least two other firm followed Carlyle’s lead: Shenkman Capital added a $40 million delayed-draw tranche to its Brookside Mill CLO and Neuberger Berman included a $35 million tranche in its Neuberger Berman CLO XIV. Both deals closed in May.

Derek Miller, a senior director at Fitch, said that both delayed draw tranches and term funding facilities give CLO managers more flexibility to ramp up deals over time.

“A year ago, CLOs were pricing and closing in two weeks, and at close had traded, if not settled, on 70%-80% of their portfolios,” Miller said. “What we’ve seen since January is most CLOs are taking four to five weeks between price and closing.”  Delayed-draw funding “gives managers additional time to source collateral.”

Scarce Collateral

CLOs have raised $41.5 billion through June 21, according to research from Wells Fargo. But they are not the only source of demand for loans. Bank loan mutual funds had pulled in nearly $26 billion of new money at mid-month. That’s in addition to money raised by private loan funds.

In comparison, $585 billion of loans were isued through June 24, according to Dealogic.  Of that figure, $342.7 billion, or nearly 60%, were refinancingsor repricings of existing debt; so net issuance of new loans is just $242.7 billion.

“A year ago, loans suitable for a new-issue CLO were trading at less than par, at 99 or 99.5. So a manager could source a full portfolio in the secondary market if they wanted to,” said Miller. In comparison, he said, new issue loans are bought at part or slightly less than par.