Pramerica CLO targets bonds to overcome loan scarcity

04/10/2013

* Manager includes big bond bucket in new CLO

* Fixed rate assets determines deal's capital structure

* Transaction prices inside previous CLO from Cairn

By Anil Mayre

LONDON, April 10 (IFR) - Pramerica's new EUR300m CLO, only the second so-called "CLO 2.0" structure to price in Europe since the crisis, allows the asset manager to buy bonds rather than having to scour the market for scarce leveraged loan collateral.

The technique appears to offer managers with a new strategy to ramp up CLO deals to a meaningful size quickly with similar assets.

In March some USD30bn of high yield bonds priced versus just under USD7bn of leveraged loans, according to Thomson Reuters LPC data.

Pramerica's Dryden XXVII Euro CLO 2013 transaction, via Barclays has a target portfolio of EUR291m of which 75% must comprise senior secured loans and bonds. However, there is no specification on the bond/loan split.

However, the current portfolio cut, as detailed in rating agency reports, shows 37% expected to be bonds. This subgroup is further split 26.01% senior secured securities, 7.9% subordinated and 3.09% senior unsecured. The remaining 63% comprises loans of varying status - 59.9% of which are senior secured loans.

Cairn CLO III, which reopened the CLO market in February, took a more concentrated view on the loan market.

Its investment rules required a minimum 90% of the EUR300m portfolio to be invested in senior secured loans. Unsecured senior loans, second lien loans, mezzanine obligations and high yield bonds are all lumped together in a bucket restricted to a maximum 10%.

In money terms, this means that Pramerica can source fewer loans than Cairn. Its target pool is EUR174.3m of senior secured loans (59.9% of EUR291m), while Cairn has to find almost EUR100m more of loans at EUR270m in a similarly sized deal (90% of its target EUR300m portfolio).

Both transactions are permitted a six month period during which they must acquire the remaining assets. In the meantime, they incur negative carry - paying out more on the bonds than they receive on the underlying loan pool.

PORTFOLIO DETERMINES STRUCTURE

Digging deeper into the portfolio statistics reveals some marked differences between the two deals, and provides other managers with evidence of how the choice of assets may affect the capital structure.

Cairn, on the one hand, put a cap of 5% of the proportion of fixed rate assets in the portfolio. This poses some interest rate mismatch risk with the floating rate bonds, although it is small. Its capital structure was entirely floating rate.

Pramerica, on the other hand, allows for 40% fixed rate securities (expected to be 33.92% of the target portfolio) according to the presales. This mismatch in risk requires mitigation, coming in the form of fixed rate bonds accounting for 30% of the capital stack.

During marketing, this 30% was covered by a EUR90m fixed slice in the Class A tranche, offered alongside EUR79.5m of senior floating notes.

At pricing the fixed senior bond amount was reduced to EUR69m and the floating portion upped to EUR100.5m. Additional fixed rate notes were also spliced into the structure down the rating scale to maintain an overall 30/70 fixed to floating split.

Pramerica must ensure at least 20% is invested in fixed securities because defaults and prepayments may affect the effectiveness of the hedge, according to Fitch. As long as the fixed instruments are within a 20-40% range, no additional hedging is required.

There are yet further differences in the structure between the two deals, providing managers with some options - namely how to satisfy the Rule 122a risk retention, or "skin in the game" requirement.

Pramerica complies with this rule by holding a vertical slice of the transaction worth 5%. Cairn, meanwhile, placed the EUR15.5m M1 equity tranche with a US pension fund.

The retention concept is a stumbling block for the development of the market, as thinly capitalised CLO managers may not have the ability to hold 5% of a deal from their own funds.

One investor said the inclusion of fixed rate note assets in this low rate environment would suits the equity holders - rising floating rates would eat into their return.

AT THE TIGHT END

Dryden came at, or through, the tight end of guidance across the structure. Having Cairn as a reference point helped, and it beat it comfortably.

The senior floating notes came at six-month Euribor plus 135bp from talk of 135bp area (the fixed notes at 2.292%), the Double A printed at 190bp from talk of low 200bp (fixed rate at 2.929%), the Single As at 290bp from talk of 300bp area (fixed at 3.929%) while the Triple B floater came at 400bp (talked at 400bp area).

The Double B tranche printed at a discounted cash price of 96.20 with a coupon of 475bp.

Cairn cleared at 140bp, 235bp, 325bp and 425bp across the Triple A, Double A, Single A and Triple B bonds. It did not offer Double B notes. (Reporting by Anil Mayre; editing by Alex Chambers)



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