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Global credit funds & CLO's
April 2024 | Issue 263
Published in London & New York.
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April 2024 | Issue 263
News
Triple A delayed-draw structure helps European CLOs beat negative carry
Triple A delayed-draw structure helps European CLOs beat negative carry
Shant Fabricatorian
CLOs
The first quarter of this year saw a trio of unusual deals in the European market: new issues that include delayed-draw options on triple A coupons. It is the first time this facility has been seen on CLO triple A notes.
Delayed draw tranches are not themselves a new feature for the European CLO market. Typically used with single B paper, a delayed draw in its traditional form gives equity investors the option to issue debt as and when spreads tighten in the future. Under this arrangement, the delayed notes can be issued after closing at the direction of the equity, and before the reinvestment period, and must all be issued at the same time.
However, according to Sid Chhabra, senior portfolio manager and global head of securitised credit and CLO management at RBC BlueBay Asset Management, the rationale behind the triple A delayed draw is different, albeit the feature is still mainly beneficial for equity investors.
“The delayed-draw feature on the triple A loan tranche provides the CLO with flexibility during the ramp phase, without the deal incurring negative carry versus a fully drawn tranche,” he says. Unlike in the case of a single-B, a delayed-draw triple A means the tranche is issued, but has a delayed-draw component to it, in order to help with matching settlements between liabilities and assets.
Chhabra adds that he sees use of delayed-draw triple As becoming more widespread, including on future BlueBay transactions. “We expect other managers will look to include the same feature,” he says.
“It provides flexibility during the ramp phase”
Sid Chhabra, Global head of securitised credit and CLO management | RBC BlueBay Asset Management
RBC BlueBay wasn’t the first manager to price a delayed-draw triple A deal this year. First out of the blocks was Fidelity, with its EUR 408.5m Grand Harbour CLO 2023-2 in late January, which featured an EUR 50m delayed-draw loan.
RBC BlueBay followed a week later in early February, with its BBAM European CLO IV. It has a delayed-draw loan valued at EUR 78m. Both tranches were priced at Euribor plus 150bps.
The third deal, Onex Credit Partners’ OCP Euro CLO 2024-9, offered a delayed-draw loan tranche sized at EUR 86.5m. It priced at 148 bps over Euribor. All of the transactions were arranged by Citi.
According to market sources, at least two of the delayed draws are short-term arrangements, featuring timelines between three and six months to fully draw down the loan tranche.
Despite the benefits of the delayed-draw structure for CLO managers and equity investors, it seems unlikely to be popular with third-party triple A buyers, who could lose out if the facility remains undrawn.
“Generally, I think lenders don’t like these undrawn facilities, because you’re making a commitment without earning spread,” says Michael Schewitz, a PM at Investec. “Typically, you do get paid an undrawn fee — but it really doesn’t compensate you sufficiently as a lender, due to regulatory and other costs.”
Schewitz added that debt investors should try to ensure the manager did not view the undrawn fee as an ‘option premium’ — as has sometimes been the case in the past — because that option is difficult to price, and typically not adequately priced in an undrawn facility.
“They should be seen as a ‘convenience fee’,” he says. “That is, if the manager is trying to ramp up a deal, it’s allowing a bit of time to be sensible and maximise the purchase of good risk collateral, rather than an opportunity to see if the overall market gets cheaper.”
The use of delayed draw as a way to combat negative carry also explains why this is, for now, an exclusively European trend. Ramping up a CLO in Europe has always been challenging, but with new loan issuance limited, and a lack of attractive paper in the secondary market, it has become a real drag on the first equity distribution. Until that changes, more delayed-draw triple As are likely.
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