Managers aren’t waiting around to see if collateralized loan obligations (CLOs) get a last-minute reprieve from the Volcker Rule. Some recently priced deals, by managers including Columbia Management Investment Advisors and Black Diamond Capital Management, have provisions for excluding investments in corporate bonds.
The final version of the Volcker Rule, released in early December, makes securitizations backed by anything other than loans or leases off limits to banks. And most CLOs, though they are backed primarily by below investment grade corporate loans, also have significant exposure to bonds. That means banks will be prohibited from owning, sponsoring, or extending credit to these deals once the rule goes into effect in 2015.
The Loan Syndications and Trading Association thinks there may be a work around, and has asked regulators to comment. The question is whether the holders of the senior notes issued by CLO, which typically have the right to remove the manager of a deal, but only for cause, should be considered to have a controlling interest.
At least two recent deals give managers the ability to invest in corporate bonds only if regulators decide favorably.
Columbia’s $447 million Cent CLO 20 has the ability to put up to 10% of its funds to work in bonds and related securities, according to a presale report published last week by Moody’s Investors Service. However this allocation is subject to what the report calls as a “Volcker Rule Consent Event.” (The quotation marks are in the report itself).
According to Moody’s, the CLO’s indenture defines a “Volcker Rule Consent Event” as one of two things: written consent of the majority of the controlling class and written advice of a reputable law firm that holding bonds will not cause the CLO to be deemed a “covered fund” under the Volcker Rule; or written consent of the majority of the controlling class and written advice of a reputable law firm that ownership of the senior notes does not constitute an “ownership interest” in the CLO under the Volcker Rule.
Columbia expects Cent CLO 20’s portfolio to be approximately 80% ramped at closing, according to Moody’s. It’s not clear from the presale report whether this 80% includes bonds or whether the manager is waiting for clarity around the Volcker Rule to make any bond purchases. It is not unusual for managers to price a CLO before all of the assets have been identified or acquired.
Morgan Stanley is the underwriter.
Black Diamond Capital Management also gave itself some leeway to change the investment allocation of its latest deal, the $412.9 million Black Diamond CLO 2013-1, once regulators clarify how the Volcker Rule applies to CLOs. As its moniker suggests, the CLO was launched in 2013, but is not expected to close until Feb. 6, 2014, according to a presale report published last week by Standard & Poor’s. The presale report indicates that the manager does not intend to invest in high yield bonds in the absence of a “Volcker Rules consent event” (quotation marks added). The presale report does not define such an event. Should such an event occur, however, the manager would invest up to 10% in a combination of high-yield bonds, secured bonds and secured floating-rate notes, with a 5% cap on high-yield bonds.
Natixis is the deal’s arranger.
Presale reports for some other CLOs in the new-issue pipeline, including Carlson Capital’s $324.5 million Cathedral Lake CLO 2013, and MidOcean Credit Partners’$372 million MidOcean Credit CLO II, make no mention of the Volcker Rule.
Cathedral Lake CLO 2013 can invest up to 5% of its portfolio in bonds and MidOcean Credit CLO II up to 10%, according to S&P’s presale reports on the deals.