A new collateralized loan obligation feature represents a skirmish in the struggle between equity investors and noteholders. The feature allows the manager to refinance a single tranche instead of calling the entire deal. Managers like the structure because of the flexibility it gives them. But the new wrinkle also means equity investors make out better than noteholders because the refinancing means less interest is going to the noteholders so more is going to the equity gang. "It's probably not something the bondholders ask for," one CDO banker deadpanned.
According to Total Securitization, a Credit Investment News sister publication, CLOs are typically structured so that after their non-call periods, the entire deal can be called and the collateral either sold off into the market or rolled into a new vehicle. Creating a new CLO incurs legal, structuring and ratings agency costs. By refinancing a single tranche, however, or simply repricing it to reflect current market values, the new feature cuts down on those expenses, one official at a CDO manager said. Having a tranche reprice at a lower spread over LIBOR means more interest can flow to the equity piece, or that interest does not get trapped in the notes.
Examples of deals with the added flexibility include the $450 million BlueMountain CLO III, the $600 million LCM Limited Partnership V and the $411 million Halcyon Loan Investors CLO II, which priced last week. Officials at the managers either declined comment or could not be reached.
The structure is likely here to stay because managers like the flexibility. "We don't want to be handcuffed to the structure," one CDO manager said. But the benefit from the bondholders' perspective was not so clear. "They would probably get a slight premium over the new issue market," the manager offered.
