3i Group Plc (III) raised a $416 million collateralized loan obligation aimed at investors willing to accept lower interest payments in order to recoup their money sooner, according to two people with knowledge of the deal.
The private-equity firm’s COA Summit CLO can buy new loans for just one year and includes a $256 million Aaa rated slice that pays a coupon of 135 basis points more than the London interbank offered rate, said the people, who asked not to be identified because the terms are private. The average time period a 2013 U.S. CLO can purchase debt is four years, according to Royal Bank of Scotland Group Plc data.
Managers of CLOs, which buy loans that back leveraged buyouts and help companies refinance, added features in the past six months such as shorter reinvestment periods to spur sluggish sales by finding new buyers for the top-rated debt. The largest portion of the funds, the AAA slice, became more difficult to sell last year after a Federal Deposit Insurance Corp. ruling designated the debt as “higher risk assets.”
“We haven’t seen this structure before,” said Ken Kroszner, a CLO analyst at RBS in Stamford, Connecticut. “There is a new buyer base attracted to shorter-term AAA CLO debt” that finds deals like this appealing.
Issuance of the funds totaled $4.4 billion during the first two weeks of February, surpassing all of January, when $2.55 billion was raised, according to RBS and JPMorgan Chase & Co. data.
Sales of CLOs rose to $82 billion last year from $55.2 billion in 2012, according to RBS. The funds were the largest buyers of leveraged loans in 2013, with a 53 percent market share, according to the New York-based Loan Syndications and Trading Association.
CLOs are a type of collateralized debt obligation that pool high-yield loans and slice them into debt securities of varying risk and return, typically from AAA ratings down to B. The lowest portion, known as the equity tranche, offers the highest potential returns and the greatest risk because investors are the first to see their interest payouts reduced when loans backing the CLO default.
With interest rates remaining near zero, companies have been increasingly cutting their cost of capital. Federal Reserve policy makers backed away from their year-old commitment to consider raising interest rates when unemployment falls below 6.5 percent. With joblessness falling, they agreed it would “soon be appropriate” to revise their guidance, minutes of their January meeting showed.
Speculative-grade companies cut interest rates on $272.4 billion of loans in 2013 through Dec. 13, according to Standard & Poor’s Capital IQ Leveraged Commentary and Data. The average yield on loans issued by U.S. companies in December was 5.1 percent, down from 6.4 percent during the same month in 2012.
While companies cut rates, AAA CLO spreads have remained wide with the majority of deals raised in February having coupons of 145 basis points to 153 basis points more than Libor, according to data compiled by Bloomberg. Spreads on AAA CLOs dropped to a low of about 23 basis points in 2007, according to Morgan Stanley (MS) data. Libor is the rate banks say they can borrow in dollars from each other. A basis point is 0.01 percentage point.
“Because CLO arbitrage is so constrained, this is a way to make it more attractive for the equity holder,” Kroszner said in a telephone interview of the shorter reinvestment period. The lower interest rate paid to AAA investors increases the cash available to be paid to equity investors.
GreensLedge Capital Markets LLC arranged the deal for New York-based 3i Debt Management U.S., which priced Feb. 14, one of the people said.
Jim Kane, a GreensLedge co-founder, and Charlyn Lusk, a spokeswoman for 3i at Stanton Public Relations & Marketing, declined to comment.
The one-year reinvestment period on the COA Summit CLO compares with an average reinvestment of 3.9 years for 2013 deals, 3.7 years for 2012 issues and 3.1 years for 2011 funds, according to RBS data.
The average reinvestment period for deals raised in 2006 and 2007 is about six to seven years, according to Moody’s Investors Service.
CLOs that have been refinanced, such as a deal for New York-based private-equity firm Apollo Global Management LLC that cut the interest rate on a AAA slice of debt in January, typically have a shorter reinvestment period because the fund has already been in place for a few years.
Apollo’s CLO, which was initially raised in 2012, had about 1 1/2 years left on its reinvestment period when it refinanced, according to Bloomberg data.
Along with a shorter reinvestment period, the 3i deal also has a shorter final maturity period of nine years, the people said. The average maturity for CLOs raised in 2011 and 2012 was about 11 years, and more than 11 1/2 years for funds issued in 2013, according to RBS.
“From a general market perspective, it is basically a question of the duration of your investment,” Leon Mogunov, a senior vice president at Moody’s, said in a telephone interview. “From our perspective, the longer the maturity the higher the default risk.”
The shorter maturity and reinvestment period allow the AAA debt to be paid a lower interest rate because the debt is repaid sooner compared with a typical deal, Kroszner said.
Bank investors pulled back from buying AAA CLO debt after an FDIC ruling that went into effect in April required lenders with more than $10 billion in assets to face a higher assessment rate on those investments.
Last year investment firms and banks added features to deals including a so-called step-up provision, where a portion of a CLO includes an interest-rate increase over the life of a fund, according to Bloomberg data.
That step-up debt was typically sold with the intention of being refinanced before the higher rate went into effect, essentially creating an 18-month investment. It was included to attract investors seeking shorter-dated debt and if the fund can’t be refinanced, the holders receive a higher coupon to make up for still owning the deal.
In contrast, the one-year reinvestment provision allows investors to start getting paid back after 12 months, rather than leaving the ability to refinance a step-up CLO after 18 months to market conditions, Kroszner said.
“We are likely going to see more refinancings and structures like this to replicate these shorter cash-flows,” Kroszner said.
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