Novel CLO Refinancing Process Enables Issuers to Skip SOFR

An online auction process that cuts costs for the biggest buyers of leveraged loans has another benefit: It allows them to delay switching to a new rate benchmark when they refinance debt.

The auction allows loan buyers known as collateralized loan obligations (CLOs) to cheaply refinance the securities they use to fund their purchases. The handful of CLOs that are eligible to use this auction process can continue to tie their borrowing to the London interbank offered rate (LIBOR) instead of embracing new benchmarks that the rest of the market had to start using this year for new transactions and refinancings.

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Continuing to use LIBOR now allows a CLO to avoid dealing with potentially costly mismatches that result from having investments tied to LIBOR while borrowing at a rate connected to a benchmark like the Secured Overnight Financing Rate (SOFR). HalseyPoint Asset Management did an auction last month, and firms including Neuberger Berman, CIFC and Seix Advisors may be candidates for future deals, according to KopenTech, the financial technology firm that organized the auction platform.

Most CLOs refinance, or reset, their borrowings through a more conventional and expensive process that requires the issuer to pay fees to banks, ratings firms, and lawyers. But KopenTech allows a different process, where all that’s changed is the rate the borrower pays. Other documentation and ratings stay the same, and the securities maintain the same CUSIP identifiers.

Because the auction is viewed as a secondary-market transaction rather than a primary-market deal, it is exempt from adhering to regulators’ guidance to switch CLO liabilities to the recommended new benchmark, Jill Scalisi, chief engagement officer at KopenTech, said in an interview.

Of course, eventually the securities will switch away from LIBOR. For U.S. dollar securities, the rate will no longer be usable for even existing instruments starting in mid-2023. And once more than half the loans in a CLO switch to SOFR or another benchmark, the CLO can change its liabilities too.

“Although you see a significant basis risk now, by virtue of having nearly 100 percent of the underlying loans in LIBOR, eventually the mismatch will correct itself,” said Nalin Aeron, an analyst at Moody’s Investors Service.

To use the online process, a CLO must have a provision in its documentation known as an applicable margin reset, or AMR, which was invented by Sancus Capital and uses KopenTech’s online trading technology. Only a handful of deals have adopted that language.

Last month, CLO manager HalseyPoint successfully used an AMR auction feature to refinance some of the debt tranches of a $378 million CLO that it originally issued in July 2020, when spreads were wide at the height of the pandemic. In addition to the cost-cutting afforded by the process, the ability to stay in LIBOR was an added benefit, said Yvonne Stevens, a co-founder and senior managing director of HalseyPoint.

“It makes it easier and more straightforward to have a match between assets and liabilities and keep it all the same. We simply reduced our spreads by 89 basis points,” Stevens said in a phone interview.

The AMR platform received $644 million in bids for the HalseyPoint deal, making the auction more than two times oversubscribed, according to KopenTech’s website. It was the sixth AMR transaction conducted since the feature was used for the first time in January 2020.

There are eight other CLO transactions with the AMR provision that will be exiting their respective non-call periods in 2022 and would be eligible for AMR refinancing, totaling over $2.85 billion, according to KopenTech.

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