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CLO managers are gearing up for the spike in defaults by buying into defensive debtor in possession financings, according to a CLO manager, two structured credit analysts, two rating agency officials and a CLO investor told Debtwire. The structured vehicles are also preparing to buy exit financings and, in some cases, to become equitized, the ratings agency officials said.
For CLOs with cash lying around and a paltry amount of new issuance to target, allocating cash to DIPs can give an instant boost to equity tranche coupons, said a CLO manager and two analysts.
Rating agencies have gotten a rash of requests for public ratings on DIPs – including Quebecor’s and LyondellBasell’s – in order to make the super priority debt CLO friendly, said both ratings agency officials. Quebecor’s DIP was originally rated BBB by Standard & Poor’s and the term loan was rated Ba3 by Moody’s Investors Service. The ratings for Quebecor and most recently Lyondell Chemical were largely at the request of CLOs, said one of the rating agency official.
Typically when a company defaults, CLO investors rush for the doors to reduce exposure, said the sources. But in the new market order of pre-petition roll-up DIPs, CLOs have jumped into the game.
For example, CLOs increased their notional allocation to the pre-petition Lyondell Chemical USD 2bn TLA and USD 9.45bn TLB by around USD 33m in order to roll up into the dollar-for-dollar USD 3.25bn DIP facility, said two analysts who tracked the numbers via Intex. The volume isn’t huge, but most structures can hold DIP buckets up to 5% of total investments and the juicy yields could help CLOs throw off excess interest, or at least offset default-related losses, noted a CLO investor and the first analyst.
Thirty seven CLOs increased their exposure to Lyondell’s term loan in the weeks before and after its bankruptcy, while six that did not hold pre petition debt bought into the loan for the first time as of 10 February, according to one analyst who tracked the most recent data available on Intex. Up to 40% of the USD 8bn Lyondell DIP was allocated for first lien loan holders who would otherwise be primed pursuant to a bankruptcy court ruling. A hearing about the DIP is ongoing.
In the case of Aleris International, nearly one-third of participants that moved into a roll-up facility similar to the Lyondell DIP were CLOs, according to a lender. The company launched DIP financing comprising a USD 500m roll-up term loan and a USD 650m ABL roll up with USD 500m in new money, as previously reported.
DIPS not for everyone, Equitization on horizon
Only CLO managers with cash can allocate new money toward a DIP, noted a CLO investor and an analyst. While 2003/2004 vintage CLOs are the healthiest, they have mostly passed out of their reinvestment periods and it is the stronger deals from the class of 2005 that are most likely to take advantage of the DIP opportunity, noted the CLO investor.
That could bring some CLO equity holders back from the brink. For example, a CLO issued in 2007 and stuffed with LBO credits saw its equity quarterly payment fall from USD 2.6m to around USD 1.3m recently, said a CLO investor who looked at the deal. DIP investing won’t be for everyone though, as some deals’ equity tranches are already under water.
Cash flow from DIPs could keep equity limping along for a few quarters but there is a clear bifurcation in the CLO market reflecting investors’ perception that cash flows will be shut off to everyone below AAA holders in the medium term. AA notes across the market are trading around 10 points, and AAAs trade at around 500bps discount margin “money good”, said the investor.
CLOs are also sniffing around exit financings. Rolling into the recently announced Quebecor World exit financing package from the DIP could be an attractive option for CLOs that can’t or don’t want to hold equity in the reorganized company, according to a prop desk trader following the exit financing.
By getting into a piece of paper issued with an OID in the low 80s, that could boost IRR with a good collateral package to boot, the trader noted.
One current Quebecor DIP lender thinks that a 15% all-in coupon on the exit financing will work if the company hits its 09 marks. The only way to safeguard the investment for CLOs is to make it shorter term and have covenants and amortizations affixed to it, he added.
In addition to DIPs, CLO managers are prepping to take their share of reworked defaulted companies. Several CLOs recently passed indenture amendments to create tax blocker structures. The purpose of the structures is to avoid the tax penalties that would come with holding equity received in a bankruptcy, said a rating agency official and two CLO managers.
For example, this week Apidos CLO 1 and ACA CLO 2005-1, both managed by Apidos, passed the amendments, according to a rating agency official.
The amendments are designed to ensure that CLOs are not deemed to be engaged in a U.S. trade or business as the result of the exchange of a loan for equity shares as part of a workout, said a second rating agency official.
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