Europe's first collateralized loan obligation after the financial crisis, called Cairn CLO III B.V., has features that are common in U.S. CLOs issued over the past two years that limit credit risk, according to a Moody's Investors Service.
Credit Suisse is the arranger on the deal, which priced on Feb. 20.
The primary market for European CLOs evaporated during the financial crisis as spreads on bonds issued by these transactions ballooned, making them an uneconomical way to raise money. New regulatory requirement for managers to retain exposure to these deals has discouraged new issuance. And the lack of commercial lending in Europe also made collateral for CLOs hard to come by. Because of these factors, Europe has been significantly bypassed by the U.S. CLOs market, which saw volume with roughly $55 billion last year.
In a report published today, Moody's said features of Cairn's CLO that limit risk include restrictions on the type of assets in the underlying portfolio, limitations on interest payment timing mismatches, caps to peripheral Europe exposures. The deal also has a shorter maturity than was typical of Europea CLOs issued pre-crisis.
Going forward, the performance of CLOs with structures similar to this deal are probably going to be more stable versus pre-crisis European transactions. Moody's expects sporadic European CLO issuance for the rest of the year with transactions having most of Cairn's structural features.
One of the deal's features that limit risk is that collateral obligations will be euro-denominated, which removes foreign exchange currency and counterparty risks from foreign exchange hedging.
None of the portfolio assets will mature after the deal's legal final maturity, which takes out the probability of selling the assets before their maturity and avoids market value risk. There is also the added requirement that the collateral manager cannot vote for amend-and-extend restructurings of any of CLO assets if this would cause a breach of the weighted average life test. The CLO also restricts synthetic obligations and structured finance assets, which were usual in pre-crisis CLOs. Having no synthetic obligations eliminates counterparty risk, Moody's explained.
Assets paying interest less frequently versus the rated notes, which pay semi-annually, cannot exceed 5% of the pool, and a reserve account will ensure equal distributions of these interest payments in the subsequent two payment dates.
Aside from these limitations, Cairn III, which has a portfolio par amount of €300 million, permits loans in specific countries that have Baa3 or higher government bond ratings, with an added restriction of 7% for those with ratings of Baa1 to Baa3. This limits exposure to Spain (Baa3 negative) Italy (Baa2 negative) and Iceland (Baa3 stable) to 7% altogether with the rest of the peripheral countries ineligible. The remaining portfolio will comprise loans in countries with Aaa foreign-currency ceilings at the loan’s purchase.
The Cairn deal's weighted average life is seven years, which is significantly less versus the typical CLO’s eight to 11 years. This lowers the rated notes' risk profile. The reinvestment period is three years, which is roughly half the average time of that of pre-crisis European CLOs. Moody's said this also reduces the portfolio variability's impact and the length of exposure to unforeseen risks.