Earlier this week, Citigroup underwrote a new $500 million CLO, ending a year-long drought that saw no new vehicles consisting of widely syndicated loans.
But while loan market participants agree that this is a positive sign, most are still skeptical of the much hyped rebirth of the CLO market, mainly because they don’t expect the pricing on new CLOs to be attractive enough.
“The [Citi] CLO looks like a red herring,” a Boston-based investor said. “I’d heard investment banks were out talking to managers about new deals, but the word I hear is that it’s not true.” The banks that have reportedly been approaching managers include JPMorgan, Bank of America Merrill Lynch and Deutsche Bank.
Citi’s new CLO, the COA Tempus CLO Ltd., will be managed by an affiliate of WCAS Fraser Sullivan Investment Management, which was formed in 2007 with the backing of private equity firm Welsh, Carson Anderson & Stowe.
Calls Fraser Sullivan were not returned, and a Citi spokesman declined to comment. FS COA Management, the Fraser Sullivan affiliate, manages four other CLOs, with approximately $1.425 billion under management.
The Tempus CLO will consist of $219.8 million in refinanced loans and $280.2 million in newly syndicated loans, primarily U.S. dollar-denominated senior secured loans made to corporate borrowers, according to Standard & Poor’s. Fraser has acquired approximately 44% of the target portfolio.
S&P has assigned preliminary ratings to three tranches of the CLO: a $327 million tranche of triple-A-rated class A-1 notes; a $15 million tranche of double-A-rated A-2 notes; and a $36.5 million tranche of single-A-rated notes. The vehicle also includes a $102.1 million equity tranche, which brings the total to $480.6 million. The total is less than $500 million because Fraser Sullivan is purchasing some the loans at a discount. So while the total value of the CLO will equal $500 million, Fraser Sullivan is raising less than that, a source familiar with the situation said.
S&P assigned the preliminary ratings based on a presale report from Citi. The ratings reflect what the tranches would look like if nothing changes with the transaction. A final rating will be given once the CLO is funded, which will likely happen within the next few months.
“The CLO is half old money, half new money,” said a New York-based banker. “It’s a good sign, but doesn’t mean that everything is fine. Maybe this means we’ve bounced off the floor a little. But we will watch it closely.”
The triple-A tranche is priced at Libor plus 190 basis points, according to S&P. The double-A tranche is at Libor plus 250 basis points, and the single-A-rated tranche is at Libor plus 225 basis points. The double-A tranche will yield approximately 3.25%, while the single-A tranche will yield approximately 4.05%, a source familiar with the situation said.
Several market participants said they expect the Fraser Sullivan CLO to come with triple-B and double-B tranches. Some sources also said they were waiting to see if those tranches would price late this week. However, whether those tranches were included, along with the price talk, couldn’t be determined.
“WCAS’s goal was to increase and extend the reinvestment period and to raise mezzanine debt,” said a CLO manager, who heard rumors that Welsh Carson may keep all of the triple-B, double-B and equity assets. “Which means their private equity funds are getting jammed with the risk to make fees in the other line of business,” he said. He added that the yields “do not work in this loan environment, given where the weighted average new issue and spread is on loans with a B2 rating.”
Like the weather outside, the CLO market is improving. Prices on triple-A-rated tranches have climbed past 90 cents on the dollar from the record low of 69 cents in April, according to Morgan Stanley data. Moreover, the average spread on the triple-A rated tranches has narrowed to Libor plus 225 basis points from Libor plus 725 basis points in April. And this has been happening against a backdrop of a strong new primary loan market.
Even though the loan market is far from the pre-crisis days, M&A is expected to surpass the $26 billion logged in the fourth quarter of 2009, when the market saw a pick-up in M&A activity, according to Thomson Reuters Loan Pricing Corp.
As of Tuesday, first-quarter M&A loan issuance had reached $17 billion, with almost half coming from leveraged issuers. Plus there is more than $24 billion in the leveraged loan pipeline. Leveraged issuance has been driven mostly by private equity sponsors. These deals include a $315 million term loan for CCMP Capital’s buyout of Infogroup, and a $450 million term loan backing Thomas H. Lee Partners’ buyout of CKE Restaurants. Corporates have also been busy. Quad/Graphics, for example, issued an $800 million term loan backing its purchase of World Color Press.
“I don’t think there is much that would derail this [improvement],” said another Boston-based investor. “Obviously, some large negative exogenous event could cool things off, but it’s hard to imagine what that could be. Seems like calm sailing for a while.”