Through the first half of 2014, CIFC Asset Management was the most prolific U.S. CLO manager on the market, structuring three funds with a combined issue volume of more than $2.1 billion.
The strong market demand for collateralized loan obligation paper by investors is no doubt a driver behind CIFC’s activity. But what has also spurred CIFC is the renewed availability of warehouse financing that allows CLO managers to collateralize a large chunk of their deals prior to issue.
“Literally on every deal that we’ve done, we’ve had at least 50% of our deals ramped in the warehouse,” said Oliver E. Wriedt, co-president of New York-based CIFC. “You could argue we’ve had over $1 billion of loans in our warehouses at different points and time.”
Warehouse lending was a commonplace feature in the CLO 1.0 era, often at 100% levels by arrangers competing for deals. But many backed off the market five years ago after being stung the collapse of the CLO market that forced arrangers to liquidate warehouse portfolios.
Today, with CLO issuance on record volume pace, warehousing is back. Market observers, including Moody’s Investors Service, now see that a large majority—perhaps up to 80% of CLOs—include an initial warehouse facility. “Almost all of the CLOs that we rate now use warehouses to aggregate loans prior to the CLO’s closing,” wrote Moody’s, in a quarterly CLO report issued in July.
Warehouse lines typically make up from 30 to 50% of a CLO, according to Wriedt. He estimates total warehouse lines this year could be from $25 billion to 28 billion, based on the first-half CLO issuance volume of approximately $65 billion (per Thomson Reuters LPC).
In its report, Moody’s noted the entrance of new equity investors, including business development corporations and CLO equity funds, willing to contribute the first-loss piece in a warehouse. The ratings agency also pointed to the various structures that investors are taking to fund warehouses beyond traditional bank credit lines, including total return swap arrangements and participation agreements on loans that CLO managers commit to purchase prior to close.
The bottom line is the new types of warehouse arrangements give back to managers the time needed to work on best-pricing arrangements for loans backing their eventual notes issues.
“It’s commonly accepted that unless you have several months during which you can buy predominantly new-issue collateral,” said Wriedt, “you really don’t’ have a shot executing on an attractively priced CLO.”
In recent years, CLO managers adapted to the lack of warehouse availability through strategies like “print and sprint,” in which they would first issue notes for their CLO and quickly access bargain secondary market loans at a discount. In these drive-by arrangements, CLO managers would obtain 40% to 50% of the target portfolio near the pricing date.
But that fell out of favor as below-par secondary loans became scarce. Banks also became more willing to issue beyond mark-to-market vehicles, frequently in swaps arrangements in which equity investors would be on the hook for additional capital if a warehouse loan-to-value ratio fell below the lender’s requirements.
“What has fueled the growth of warehouse availability is really the vibrancy and viability of the CLO market,” said Goran Puljic, co-head of structured products and a partner with Oak Hill Advisors.
With demand increasing for CLO notes, warehouse investors became less concerned about acquiring the preferred shares or subordinated notes of a first-loss position with CLOs that are more than likely to carry through to close in a hot market. “The safest time for a loan’s life is the first few months,” said Aaron Peck, the chief investment officer and chief financial officer for Monroe Capital Corp., the BDC arm of Monroe Capital in Chicago.
These equity investors in the warehouse tranche, including BDCs, family offices, and CLO equity funds, have also found warehouse lines attractive. According to Wriedt, these third-party investors are using the warehouse to roll up into a position in the CLO at close, or sell their position prior to issue for a tidy profit spread of as much as 120 bps to 125 bps.
Some funds have even committed to investing solely in warehouse lines, according to Wriedt. While not exclusively warehouse, the Blackstone Group recently formed a CLO equity fund (Blackstone/GSO Loan Financing Ltd), primarily to invest equity in its own CLOs.
“There a good deal more variety of sources than their used to be, and there’s also quite a variety of structures in the market,” said Neil Hamilton, a London-based partner for law firm Paul Hastings.
Hamilton and Wriedt each noted the choice of warehouse structures varies mostly by arranger preferences. Some banks make warehouse lines available to draw arrangement business, while others steer their warehouse investors to participation or swaps arrangements. “Some banks have gotten very comfortable with their own internal ratings systems, like a Wells Fargo who’s been very active in warehousing since re-opening of market in 2010,” said Wriedt. Other banks, though, think “we can still get business done with TRS-based warehouses, so let’s just stick with those,” he said.
CIFC, which only works under non-mark to market arrangements with its warehouse lines, has been able to work out such arrangements through banks such as RBC, Credit Suisse, Citibank, BNP Paribas and Wells Fargo. “We really think why take the risk if you don’t have to?” said Wriedt.