Shorter non-callable periods are gaining traction as a way for CLO managers to avoid rules that will require them to keep “skin in the game” of deals printed after December 2016.
More than one-third of collateralized loan obligations that closed between January and May of this year have non-call periods less than the standard two years, according to Moody’s Investors Service. This allows the deals to be refinanced before risk retention rules enacted as part of the Dodd-Frank Act take effect. These rules require managers to purchase and retain 5% of the fair value of any CLO issued after Dec. 24, 2016. While it’s not entirely clear how refinancing will be treated under the new risk retention rules, many participants believe that these transactions should not be considered a new securitization.
In a report published today, Moody’s said that of the 67 CLOs it sampled that closed in the first five months of the year, 25 have non-call periods of less than two years. The CLO notes that are being refinanced are redeemed and new notes with a lower interest rate are issued; they may be purchased by the original investors or by new investors.
The Loan Syndications and Trading Association, an industry trade group, has been lobbying regulators to issue a no action letter making it clear that refinancing existing CLOs will not subject them to risk retention. The LSTA’s argument is that, other than the lower interest rate, all of the other terms of the original transaction remain in place. The maturity date of the transaction is not extended, the capital structure of the transaction does not change, and the principal amounts of the classes of securities remain the same.
Also, no additional securities are issued and no additional funds are available for the purchase of additional assets by the CLO.
Moody’s thinks that shorter non-call periods are generally credit positive because they allow senior investors to recoup their investment earlier. They also allow the CLO to lower its debt servicing costs, which means that are more funds available to holders of the junior notes and equity.
Only one of Moody’s-rated CLOs that closed in the past two weeks, the $600 million Octagon Investors Portfolio XXIII, has a short non-call period; it can be refinanced after October 2016, two months before risk retention rules take effect.
At least four others -- the $500 million Carlyle Global Markets CLO 2015-3, the $500 million Sound Point CLO IX, the $400 million Neuberger Berman CLO XX, and the $500 million CIFC Funding 2015-III, have non-call periods of two years or more, meaning that they cannot be refinanced until after risk retention rules take effect.