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Flatiron CLO reflects structural changes providing more flexibility

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NYL Investors’ $400 million Flatiron CLO 20 incorporates increasingly common provisions giving it more flexibility in today’s uncertain credit environment, according to a presale report from Fitch Ratings.

Fitch notes that the Class A notes, a $252 million AAA-rated tranche, benefit from credit enhancement of 37.0% and standard U.S. CLO structural features.” The deal is split into five rated tranches and a $38.475 million residual subordinated piece.

Among several deal highlights Fitch notes is an Oct. 1 change to the Volcker Rule, which was enacted in response to the 2008 financial crisis, that permits CLO issuers to acquire senior-secured bonds, senior-secured notes, and high-yield bonds at up to 5% of the collateral principal amount.

That change does not represent a significant event for CLOs, said Aaron Hughes, senior director in Fitch’s U.S. structured credit group, since they have had flexibility to include such assets through springing bond buckets baked into the documentation or amendments often requiring investor consent. He added that Fitch does not view the change as a credit risk issue since it already stresses portfolios to their maximum second-lien or non-senior-secured loan exposure, “And that stress is more punitive than a bond exposure.”

Fitch also points to the deal’s provision for loss mitigation loans, which can be purchased by the issuer using principal or interest proceeds in connection with the workout, restructuring, or related scheme to mitigate losses related to defaulted or credit-risk obligations. Hughes said Fitch has seen this provision become increasingly common over the last year as managers look for greater flexibility in today’s uncertain environment.

“It provides collateral managers with more flexibility to purchase or receive assets that are, in their view, likely to have a higher recovery than the distressed defaulted loans they were holding previously,” he said.

Fitch notes that the Flatiron transaction does not incorporate significant elements of the Alternative Reference Rates Committee (ARRC) recommendations for robust fallback language, should the Libor benchmark over which pool’s loans are priced become no longer viable. Hughes said approximately half of CLOs in 2019 carried the ARRC language and that percentage has jumped to 70% this year.

The remaining 30%, however, are not at risk when transitioning to a Libor alternative becomes necessary.

“What’s important is whether the transaction has fallback language that’s clear and flexible enough to adjust to whatever new rate will be adopted by the market,” Hughes said, “And in this case and with almost every CLO, the answer is ‘yes.’”

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