First-time managers of collateralized loan obligations are rushing to put together deals before new regulations designed to curb risk make it more expensive to do so.
At least nine managers including Moelis Asset Management LP’s Steele Creek unit issued their first CLO this year, according to data compiled by Bloomberg and Moody’s Investors Service. New managers accounted for 10 percent of issuance during the first half of 2014, up from 4.5 percent last year, Moody’s data show.
There’s a sprint to lock up assets that generate steady fees before regulations are enacted which, as proposed, would require managers to hold onto 5 percent of the debt they package or sell. The rules are expected to be completed this year and will hurt smaller managers the most because many won’t have enough capital to comply, said Ken Kroszner, head of CLO strategy at Royal Bank of Scotland Group Plc.
“CLO managers are, quite frankly, trying to ramp up as much” assets “as possible given the open window of demand and impending risk-retention” rules, Kroszner said in a telephone interview from his Stamford, Connecticut, office.
CLO issuance reached a record $60.7 billion during the first half of the year and JPMorgan Chase & Co. and Wells Fargo & Co. forecast it will climb to as much as $100 billion in 2014. The boom is helping fuel demand for high-yield loans, a market that U.S. regulators have said shows signs of froth.
First-time issuers have raised about $4 billion through CLOs this year, according to Bloomberg and Moody’s data. The managers include Bradford & Marzec LLC, an investment firm that oversaw $4.6 billion as of March 31, and Triumph Capital Advisors LLC, which oversees about $400 million and is a unit of Triumph Bancorp Inc. in Dallas.
“Having a substantial” amount of assets under management is important for the “survival” of some firms, said Yvonne Fu, a managing director at Moody’s in New York. “Having a number of deals under their belt is important and current market conditions are quite favorable to get deals done.”
Steele Creek, which was founded in 2013, issued its first CLO last month with a $413.5 million deal, according to a person with knowledge of the plan, who asked not to be identified because the terms are private.
Andrea Hurst, a Moelis spokeswoman, declined to comment. Amanda Tavackoli, a Triumph spokeswoman, and Bradford & Marzec co-founders Edward Bradford and Zelda Marzec didn’t return telephone calls seeking comment.
The new regulation is intended to make sure managers are on the hook for at least a portion of the risk in their deals. It’s part of the 2010 Dodd-Frank Act enacted in response to the credit crisis that was fueled in part by securitized debt, particularly in the mortgage market.
“Regulators have stated they felt that because no one involved in those mortgages had any skin in the game, that helped lead to lower underwriting standards,” said Dave Preston, a CLO analyst at Wells Fargo in Charlotte, North Carolina.
An updated proposal of the rule was released by regulators including the Federal Reserve and the Office of the Comptroller of the Currency a year ago. Only 2 percent of the 719 U.S. CLOs that purchased widely syndicated loans and were graded by Moody’s between January 1996 and May 2012 lost any of their principal at maturity, according to a report two years ago from the credit rater.
The proposal would also make banks hold onto a portion of a term loan they arrange and sell to CLOs without the ability to hedge or offload it. There were $82 billion of CLOs arranged in 2013, according to RBS data.
CLOs pool high-yield corporate loans, which are often used to finance leveraged buyouts, and slice them into securities of varying risk and return. Last quarter, the funds bought 63 percent of loans, according to the Loan Syndications and Trading Association, which cited Standard & Poor’s Capital IQ Leveraged Commentary and Data.
Once enacted, the new rules may slow CLO sales by as much as $250 billion, according to an LSTA-sponsored study conducted by New York-based consulting firm Oliver Wyman.
Only a third of the top 30 managers would probably have the capital to hold 5 percent of their existing CLOs on their balance sheet, according to the report, which was released in December. Those managers are primarily affiliated with a large insurer or large alternative-asset manager and represented about 27 percent of the market. The rules would probably not apply to existing deals.
“A lot of newer managers haven’t come from deep pools of money, which is why they will likely have more difficulty complying with retention rules,” Kroszner said. “Managers without an established track record may have a harder time issuing CLOs in a post-retention world.”
Medium-sized managers, those with five to nine deals, accounted for 28 percent of CLOs during the first six months of the year, compared with 18 percent in 2013, according to a Moody’s report last month.
Since the start of 2012, about 30 firms have issued their first CLOs including investment firm Oaktree Capital Management LP, which oversees more than $91 billion, and Onex Credit Partners LLC, the credit-investment group of Toronto-based private-equity firm Onex Corp., according to Bloomberg, Moody’s data and the firms’ websites.
Carissa Felger, a spokeswoman for Oaktree at Sard Verbinnen & Co., declined to comment. Emma Thompson, an Onex spokeswoman, didn’t return a phone call seeking comment.
As existing deals mature and fees dwindle, many investment firms will probably try to sell their CLO businesses, according to Wells Fargo’s Preston.
“For most managers, as the rules are written now, it would be difficult to issue CLOs after risk-retention rules come out,” he said. “When those deals begin to amortize, those CLO management platforms or contracts will likely be sold.”