Rules requiring skin in the game of CLOs and other kinds of asset-backeds haven't played out quite as expected.
Some of the predicted impacts, such as a decline in issuance of collateralized loan obligations and reduction in financing for below-investment-grade companies, were clearly overstated. Issuance got off to a slow start this year, but at over $72 billion, has now topped volume for all of 2016.
The rules have also had some unexpected consequences, such as a scarcity of "equity," a term for the most subordinate securities issued in deals. CLO managers at an ABS East panel Monday discussed how they have had to adjust their investment strategies because of shrinking opportunities to put money to work in the equity of other managers' deals.
“There are certain platforms and programs that we love to buy a majority-equity position in that’s just not available anymore,” said Matthew Andrews, a managing director and head of structured products at CIFC Asset Management. “We haven’t found it prohibitive by any means. It’s just there are fewer opportunities there.”
The same goes for the investors who used to take out stakes in the equity of CIFC’s own managed CLOs, too. “Since risk retention started, we’ve issued four new transactions. We’ve bought the majority equity on all of them,” he said. Of the 19 post-crisis deals done before those four, CIFC only bought a majority equity stake in one of them – the inaugural post-crisis portfolio sold in 2011.
“It’s just a totally different business model.”
Matt Natcharian, a managing director and head of the structured credit CLO investment team at Barings, echoed Andrews. He noted in the same panel discussion that risk retention has “changed how equity is raised, and it’s brought in a stabilization of equity demand.”
Managers needing to retain a 5% minimum stake in deals means they must raise capital (through majority-owned affiliates or third-party funds), so they can “plan well ahead on how they are going to issue a program of two, three or four CLOs a year, and reset or refinance their older deals.”
By pursuing a diverse set of investors to help them find the equity money, and handling this pursuit themselves, deals have fewer costs with banks being less involved with matching equity stakes to investors like in the pre-risk retention days, said Natcharian. “Because they are investing in it as well, I think it’s created a lot of stability. I think it has also compressed fees which have helped equity returns.”
An audience poll of investors on Monday indicated that investors, issuers and other market participants also feel risk-retention has provided more benefits than expected.
When asked to rate the impact of risk retention on the CLO market, a whopping 70% said it had less of an impact than expected. Only 12% said it had a greater effect on the market than they anticipated prior to the enforcement period that began last December on new-issue collateralized loan obligations.