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July 05, 2019  

CLO Issuers Pursuing Broader Syndication

Norinchukin Bank has paused its purchases of U.S. CLOs in recent months, prompting some underwriters to change their distribution tactics.

As one of the sector’s biggest investors, Norinchukin has been known to take “anchor” positions in new deals encompassing half or more of certain transactions’ triple-A-rated senior notes. But with the Tokyo institution on the sidelines, the banks that previously might have counted it as a buyer instead are forgoing the sales of anchor positions.

Instead, the arrangers are syndicating the securities among larger numbers of investors including regional and community banks in the U.S. Those buyers are picking up no more than $25 million of securities at a shot, out of senior classes that often total $250 million to $300 million.

Normally, the absence of an investor as big as Norinchukin would result in a widening of spreads. In this case, however, deals without senior anchor buyers are pricing at similar levels to those with them — in some instances even tighter.

Why are the transactions faring so well? Some believe Norinchukin had been bidding wider than other investors in an effort to demonstrate to Japan’s Financial Services Agency that it isn’t solely responsible for current market levels despite its outsized presence. In the past, the bank also has stepped back periodically to see where deals clear in its absence.

Other market participants think Norinchuken may simply have gotten greedy in a push for higher yields.

Consider a $404.3 million deal that PGIM Investments priced on April 25 under its Dryden CLO program. Bookrunner Goldman Sachs originally lined up Norinchukin to take a majority of the deal’s $256 million senior tranche. However, its bid was so wide that Goldman ended up syndicating the class to a much larger group of investors, at a tighter spread of 133 bp over three-month Libor. The deal had a two-year non-call period and five-year reinvestment window.

At the time, that was a rare event for a larger issuer. At least 85% of U.S. CLOs issued in 2017 and 2018 had senior anchor investors, one source estimated. While it’s uncertain where that percentage sits now, it’s clear that a number of well-known issuers including CIFC have found broader distribution to be a workable tactic. “It definitely shows the depth of the triple-A investor market,” the source said.

“Until a few weeks ago, Nochu set the market and it came in narrow,” another source said. “Now it’s coming in wide . . . and arranger banks are open to bids [from other investors] that are a little wider than Nochu used to be, but still tighter than where Nochu is now.”

CLO securities with triple-A ratings and two- or three-year reinvestment periods currently are pricing around 125-135 bp over three-month Libor, while those with four- or five-year reinvestment periods are selling around 135-145 bp.

Another possible factor in Norinchukin’s move away from the market: The FSA’s March 31 implementation of new risk-retention rules. Under that measure, Japanese financial institutions can invest only in structured products if the issuers keep 5% stakes in the deals or the buyers can prove the underlying assets weren’t “inappropriately formed.” But those conditions have had a far greater effect on the habits of smaller banks, as robust due-diligence processes at larger shops including Norinchukin and Japan Post Bank generally have qualified them for exemptions.

Still, Norinchukin’s wider bids could help it demonstrate that it isn’t buying indiscriminately, sources said.

Norinchukin is among 10 or so investors that take anchor stakes in CLOs. Some of the biggest U.S. banks also are in that group. In addition, Deutsche Bank is building a portfolio of senior CLO securities, according to S&P.

While broader syndication requires more work, there are potential advantages for sellers. Because non-anchor investors have less bargaining power, the issuers can implement terms that Norinchukin resisted. For example, they can manage cashflows in a way that is more advantageous to equity holders. They also can modify collateral-quality tests and give themselves some flexibility to deploy capital after the deals’ investment periods end.

“If an investor is not buying a controlling position of a tranche, it just doesn’t have the leverage,” one source said. “You’re not going to fight to the death. Whereas if Nochu buys more than 50%, it has the controlling vote in tranche.”