TRLPC: Carlyle CLO twice raises rate paid as spreads fail to tighten

By Kristen Haunss

NEW YORK (Reuters) - A Collateralized Loan Obligation (CLO) managed by the Carlyle Group increased for the second time the rate it must pay to some of its most-senior investors, about 31 months after it was issued with the intention of being refinanced before the spread rose.

Carlyle, the Washington-based investment firm that oversees US$188bn in assets, raised the CLO, Carlyle 2013-3, with a US$75m Triple A slice that paid a below-market spread of 100bp for the first 18 months, sources said. That rate increased to 150bp in January 2015 and stepped up again to 175bp on January 15.

Carlyle and GSO Capital Partners are among investment firms that issued funds with this step-up structure following a staggering 68% drop in CLO issuance in 2013 amid changes in regulation.

An April 1, 2013 assessment by the Federal Deposit Insurance Corp (FDIC) made it more expensive for banks, holders of the Triple A tranches of CLOs, to issue new funds after requiring banks to incur higher deposit insurance premiums on their CLO holdings. When new CLO issuance dropped to US$3.9bn in April from US$12.3bn in March, the new structure was slated to entice to the CLO market new buyers seeking shorter-duration bonds.

The funds were meant to be in place for 18 months and then be refinanced before the interest rate increased. If the deals couldn’t be reworked, the investor would be paid a higher spread.

CLOs, which pool loans of different credit quality, sell slices of the fund of varying seniority, from Triple A to B, to investors such as insurance companies. The most junior and riskiest portion of the fund, the equity slice, is paid last with what interest is leftover after the fund’s bondholders receive their distributions.

“The concern from the CLO market was that you had an increase in the number of regional banks who became a fairly substantial part of the CLO investor base when the market reopened after the crisis and there was concern about how many banks would have to pay a higher insurance charge [for holding CLO tranches],” Rishad Ahluwalia, global head of CLO research at JP Morgan in London, said of the FDIC assessment.

The feature was intended to attract investors that wanted to purchase a shorter-dated bond with a higher interest rate. These tranches typically paid about 100bp-110bp compared to three-year Triple A prime auto bonds that paid 30bp in October 2013 or three-year Triple A subprime auto bonds that paid 56bp, according to Wells Fargo data.

“The point is to effectively shorten the bond for the investor,” said Bjarni Torfason, a CLO analyst at Deutsche Bank in New York. “It doesn’t guarantee they will get their money back when the coupon steps-up, but it makes it very likely they will get their money back at that time and otherwise provides them with a high coupon bond that could likely be sold at a good price.”

In June 2013, when the Carlyle 2013-3 CLO was issued, Triple A spreads were about 120bp and forecast to drop to about 100bp at the end of the year. Triple A spreads finished 2013 at 150bp, according to Morgan Stanley data.

When the fund, which was arranged by Citigroup, stepped up to 150bp in January 2015, spreads on new-issue Triple As were at 155bp.

The second step-up to 175bp on January 15 is higher than the market spread of about 154bp at the end of 2015. Carlyle’s most recent US$406.85m CLO issued in December, also with Citigroup, pays investors in a US$209.5m Triple A slice 155bp, according to LPC Collateral data.

Carlyle and Citigroup spokespeople both declined to comment.

RECORD REFI

A record US$11.6bn of CLOs was refinanced in 2015, primarily in the second quarter when Triple A spreads dipped below 150bp. Cutting the interest rate on the Triple A tranche can increase payouts to equity holders.

GSO, the credit-investment unit of Blackstone Group, raised a US$519m Emerson Park CLO with Goldman Sachs in 2013 that included the step-up feature, sources said. The spread on that Triple A slice increased to 150bp in April 2015 from the issued rate of 100bp, sources said.

The fund was then refinanced in July 2015, cutting the Triple A spread to 132bp, sources said. If it hadn’t been reworked, the next step-up would have been to 175bp on April 15, 2016.

A GSO spokesperson didn’t return a telephone call seeking comment. A Goldman Sachs spokesperson declined to comment.

The step-up feature largely disappeared from the market in 2015 until Allstate raised a US$501m CLO with Goldman Sachs in November that included a spread increase on a US$45m Triple A slice, which was driven by investor demand, sources said. The fund currently pays a coupon of 155bp that will step up to 185bps after 24 months.

More funds may be issued with this feature if there is investor demand for CLO debt with a shorter duration, managers and bankers said.

(Editing By Michelle Sierra and Chris Mangham)

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