By Kristen Haunss
NEW YORK (Reuters LPC) - The US Collateralized Loan Obligation (CLO) market is attempting to set a standard timeframe for managers to disclose how much risk they intend to hold to comply with Dodd-Frank regulation, even as President Donald Trump pushes ahead with plans to dismantle the law.
Regulators want managers to give fair value determinations before CLOs are priced to give potential investors enough time to understand the calculations. A set timeframe could allow CLOs to be issued more quickly, removing another brake on new issuance, which has fallen for the last two years and is expected to drop again in 2017.
Risk-retention rules that require CLO managers to hold 5% of their deals came into effect in December and prompted more pessimistic bank forecasts of a 30% drop in CLO issuance in 2017. As CLOs are the biggest buyers of leveraged loans, this could leave less capital available to fund new leveraged buyouts or help companies refinance.
Under Dodd-Frank regulation, CLO managers that want to buy a horizontal retention slice have to show the calculation used to determine the size of the holding.
Managers can buy 5% of every tranche of a CLO, known as a vertical strip to comply with US risk-retention rules, or 5% of the face amount of all of the fund’s tranches, which is known as a horizontal strip, and held in the most junior equity tranche. Managers can also purchase a combination of vertical and horizontal strips.
The exact timing for the disclosure is still being decided, but managers must describe a range for what fair value is expected to be in the last preliminary offering document before pricing, according to Deborah Festa, head of law firm Milbank, Tweed, Hadley & McCloy’s West Coast securitization and investment management practices. Managers then have to disclose precise fair value when the CLO closes.
“There is a lot of negotiation happening now and the market will settle on norms and methods of disclosure and timing,” Festa said.
Managers that choose horizontal strips are required to disclose the fair value of the entire capital structure and the fair value of the retained interest to investors, Festa said, and will also need to include a description of what fair value is and the methodology used in a fund’s offering documents.
As fair value is determined using assumptions and there are significant unknowns before pricing, managers are allowed to give investors a range rather than the specific determination, according to William Fellows, a partner in Deloitte & Touche’s valuation and modeling practice.
When CLOs close, fair value is calculated for every tranche to ensure that collateral managers keep equity equal to at least 5% of the entire deal, according to Cindy Ma, global head of the portfolio valuation and fund advisory service practice at Houlihan Lokey.
Apex Credit Partners, a unit of Jefferies Finance, which priced its US$453.85m JFIN 2017-1 CLO with Jefferies last month, said that the manager will buy a horizontal retention slice, sources said.
CIFC, which manages about US$13.7bn in assets, is also planning to retain a horizontal strip to comply with US risk-retention rules in a CLO it is raising with Deutsche Bank (DE:DBKGn), according to sources.