Creditflux logo.svg
Global credit funds & CLO's
May 2024 Issue 264
Published in London & New York 10 Queen Street Place, London 1345 Avenue of the Americas, New York
Creditflux is an
© Creditflux Ltd 2024. All rights reserved. Available by subscription only.

Banks embrace triple A loan tranches following Supreme Court decision

by Paul Conley
Loan tranches for triple As are having a moment. A variety of CLOs in recent weeks have been structured with a loan tranche at the top of the stack, which, according to market participants, points to the involvement of US bank triple A buyers.
Banks that are said to be possible investors in the tranches include Bank of America, Wells Fargo, JP Morgan, Key Bank, Barclays and State Street.
The reason for the format is the court ruling last year that loans are not securities and don’t need to be treated as such on a bank’s balance sheet.
“Typically, it’s a bank trying not to hold the investment in its securities bucket. Loans have a better regulatory capital charge than securities,” said Arlene Shaw, a managing director at Brightwood Capital.
In August 2023, the US Second Circuit Court ruled in Kirschner v JP Morgan (known in the CLO industry as the Millennium Health case) that a syndicated term loan is not a security. The court found that three factors — the plan of distribution, the reasonable expectations of the public and the existence of other risk-reducing factors — suggested that a term loan should not be classified as a security.
The bank doesn’t want the investment in its securities bucket
Arlene Shaw
Managing director Brightwood Capital
At the time, industry insiders said the decision was likely to drive investments in loan tranches by banks. But bank attorneys waited until the US Supreme Court weighed in. On February 2024, the court essentially did that by declining to review the case.
Since then, a number of CLOs with triple A loan tranches have priced. In recent weeks the market saw sizeable loan tranches in a wide variety of CLOs, including Northwestern Mutual’s new BSL deal 720 East CLO V; Angelo Gordon’s MM CLO Twin Brook 2024-1, and even a European CLO — Sona Fios CLO II. Palmer Square’s latest static CLO, Palmer Square Loan Funding 2024-3, had 62% of the triple As arranged as a loan.
In many cases, banks are investing in loan tranches in CLOs they have not arranged. The investments are being made “independently from the CLO desk”, said one person with knowledge of several deals.
Loan tranches are not a recent invention. They have been a feature of some CLOs since the earliest days, and for many years were a sign of the involvement of Japanese banks.
Even if the Millennium Health case had never happened, or if the CLO industry was still waiting on a Supreme Court ruling, triple A loan tranches would still be part of the landscape. But now the law is clear, industry watchers expect loan tranches will become more common.
“I think it depends on the value proposition in the market,” Shaw said. “More banks will participate as long as the value proposition is high enough.”