Ares Capital is preparing a collateralized loan obligation that will acquire the majority of its initial portfolio from one of its existing funds.
The deal, Ares XXVI, will be backed by $898.7 million of broadly syndicated corporate loans, according to a presale report published today by Moody’s Investors Service.
Moody’s flagged as a concern the fact that the issuer will acquire approximately 70% of the portfolio through a participation agreement with an investment fund whose manager is an affiliate of the CLO’s manager.
Loan participations account for an estimated 10% of cash loan trading in the U.S. In this kind of transaction, the original lender sells the rights and risks associated with a loan, but remains the lender of record. Any interest paid by the borrower comes to the new investor through the original lender, which acts as an intermediary.
Loans change hands this way because loan documents often give borrowers the explicit right to consent to, or disallow, the transfer of the loan from one investor to another.
Moody’s said that, under the participation agreement between Ares CLO XXVI and the selling fund, “the seller and the issuer will be obligated to take such actions as are necessary, as soon as reasonably practicable, to elevate the participations of the transferred collateral to assignments of them.”
Nevertheless, Moody’s said, it is possible that a significant portion of the transferred collateral will not ultimately be elevated to assignments, in which case the issuer would be exposed to: the counterparty risk of the seller, the risk that the seller does not comply with its covenants under the participation agreement, the existence or creation of additional liens on the transferred collateral, and the operational risks of relying on the seller passing on the cash flows of the underlying assets.
Ares CLO XXVI has some other unusual features. The senior tranche of $560 million notes provisionally rated ‘AAA’ by Moody’s, is being marketed at Libor plus 111 basis points, well below spreads on recent deals.
There is also a $50 million tranche provisionally rated ‘A3’ by Moody’s that does not pay interest; it will presumably be sold at a discount to face value, with investors receiving only principal payments.
The remainder of the deal is unrated.
Ares CLO XXVI also has a broader investment mandate than many recent CLOs. At least 92.5% of the portfolio must be senior secured loans, a minimum that’s fairly typical. However, an unusually high portion of assets, 20%, may be invested in revolving lines of credit. The CLO can also invest up to 70% of assets in covenant-lite loans.
The deal is expected to close on Friday March 8. It has a three-year reinvestment period. The presale report does not indicate when the deal will be eligible to be called.