This is the first time the life of a European CLO has been extended instead of being called or allowed to amortise before the end of its re-investment period.
“Annual prepayment can be as high as 35%, a rise of about 5% since 2003 and an increase of around 10% compared with four years ago,” said Oliver Burgel, a director at Babson Capital. “We had to extend the vehicle to remain fully invested.”
Duchess I is an older CLO vintage with a 12-year maturity investing primarily in senior secured and mezzanine loans. The fund closed initially in June 2001 at €750m, but was increased to €1bn after a €250m tap in February 2002. Without the typical 15 or 16-year maturity of newer vintages, which helps to amortise start-up costs, the fund was unable to invest in higher-yielding loan assets after the first four years. “Extending the older vintage CLOs has been viewed by some as a market taboo. Investment banks have advised against it, but, when you think about it, they probably want to do a new deal and collect the fees,” a market source said.
After the first four years, Duchess could not invest further in mezzanine or term loan B and C tranches, meaning that returns and choice of assets were reduced. Mezzanine pays subordinated pricing, while term loan Bs and Cs typically offer 50bp to 75bp above the revolver and term loan A tranches.
If it did not extend Duchess, Babson could have sought assets in the secondary market. However, most European loans have been over par for much of this year. It is only in the last three or four weeks that large LBOs such as Amadeus and Debenhams have been breaking at a discount.
Through the amendment, the maturity of Duchess I has been extended by four years until 2017. As part of the process, various other features were incorporated into the fund to reflect advances in CLO structuring during the past four years. These include a covenant matrix, which means that if the fund outperforms on spread it has flexibility to underperform on rating. These factors are increasingly important as loan spreads have become more volatile.
Babson said that the amendment of Duchess might pave the way for other CLO funds of this vintage to follow suit. According to market sources, AIB could have a similar development in the pipeline, although Axa is understood to be winding down one of its earlier debt vehicles.
Investors were receptive to the extension. Of the votes cast, 98.45% of Class A investors, 100% of Class B investors and 100% of secured income note investors voted in favour of the move. Pricing on the AAA notes was reduced from 52bp to 42bp, a level that is still attractive compared with the market average of 25bp. Babson has also extended the non-call feature on the facility to three years, enabling investors to lock in the gain.
“The support for the amendments illustrates that the maturity extension is attractive to all classes of notes,” said Ian Hazelton, chief executive of Babson.
European pre-payment rates are unlikely to trigger a refinancing binge as seen several times over the last few years in the US loan market, however. This is because the market is still two-thirds controlled by banks, while US institutional penetration is about 70%. European revolvers are also multi-currency facilities, which do not work efficiently in CDO structures.