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Landmark Starwood project finance CLO opens door to new asset class

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By Paola Aurisicchio
04 Mar 2021

MUFG has introduced a new CLO asset class, bundling $500m of project finance and infrastructure loans together for Starwood Property Trust, in a deal that clearly demonstrated investor appetite for the product. Other issuers could follow, raising capital for the forthcoming US infrastructure building plan potentially worth $2tr, writes Paola Aurisicchio.

In 2017, Deutsche Asset Management subsidiary Rreef America worked on an early project finance CLO dubbed RIN. The CLO was still a "hybrid", according to people familiar with the deal, because it was backed by project finance loans and leveraged loans. But since then, moves towards a pure project finance-backed deal have stalled.

MUFG started working on the project finance CLO more than a year ago, as GlobalCapitalreported, considering it to be a natural extension of the bank’s expertise in project finance lending and structuring.

But the process took longer than expected as the Japanese bank had to go through a new rating methodology and a review of the loans, while the pandemic disrupted the new issue market for much of last year.

Moody’s classified the deal, STWD 2021-SIF1, as a CDO, mainly to distinguish it from regular CLOs backed by corporate loans.

"The deal is a great example of using existing CLO technology with a new asset class," said TriciaHazelwood, international head of securitized products at MUFG. "It allows investors to get value through an increase in spread with better performing collateral. The financing costs are also very attractive.

"It also comes out at a very opportune time with a strengthening US economy and a new administration with an increased focus on ESG. There could be potential for a next generation of CLOs that are backed by project finance loans with an ESG framework."

The $300m class Aaa notes were priced at 150bp over three month Libor; $50m of Aa3 notes were sold at 190bp, the $25m A3 notes at 235bp and $35m of Baa3 notes at 390bp. There are also $90m of unrated preferred shares.

At least 60% of the portfolio consists of project finance infrastructure in the power generation sector and 15% in project finance infrastructure in the oil and gas sector.

The deal includes an ESG screen that prevents it purchasing assets issued by any company that receives more than 50% of its revenue from the “speculative extraction of oil and gas from tar sands or arctic drilling or thermal coal mining”. This, however, does not prevent the vehicle being exposed to oil and gas infrastructure in other areas.

Starwood Property Trust chief operating officer Andrew Sossen said its first energy infrastructure CLO would be "the first of many for Starwood Infrastructure Finance".

Rating challenges

The deal contains some features similar to broadly syndicated CLOs, and others more like a middle-market CLO, which made it challenging. It is more concentrated than a broadly syndicated loan (BSL) CLO. Meanwhile, like middle market CLOs, the underlying obligors are not themselves rated, so they had to go through a process of credit estimates.

There are a minimum of 30 obligors on this deal, in contrast with a typical BSL CLO, which will have more than 80. But Mahesh Assomull, CLO structurer at MUFG, said that a key difference was that "this CLO has a much better credit quality compared to a BSL CLO. It also tends to be less correlated to macroeconomic trends as it is backed by projects with unique characteristics that are not related to bigger market trends".

The deal attracted banks, pension funds, and asset managers familiar with CLOs but it may also bring into the market new investors who are eager to gain exposure to project finance without building a dedicated internal investing capability to buy the loans directly.

The transaction comes at a time of growing interest in project finance and infrastructure investment in light of US president Joe Biden's $2tr infrastructure-rebuilding plan that contains ambitious climate change goals.

By Paola Aurisicchio
04 Mar 2021