CLO Bankers May Lose Out If This Startup Has Its Way

(Bloomberg) -- A startup conducted an online auction recently that could revolutionize the way the biggest buyers of leveraged loans fund themselves.

The auction allowed a loan buyer known as a collateralized loan obligation to cheaply refinance the securities it had issued to fund its investments. The CLO saved hundreds of thousands of dollars in fees, compared with a more standard refinancing through a Wall Street bank.

The firm that organized the auction, Los Angeles-based KopenTech, may not find it easy to get the marketplace to embrace its technology. It has to convince Wall Street banks to participate in auctions that threaten their profits. And it has to persuade CLO managers to insert a special provision in legal documents when selling the securities, because right now only about seven CLOs are legally able to use the system, out of more than $660 billion outstanding.

But the potential cost savings for issuers are high enough that buyers of CLO equity may press for more investment firms to use KopenTech’s technology, Moody’s Investors Service analyst Peter Hallenbeck wrote in an emailed comment. There were $25 billion of CLO refinancings last year. If all of them had gone the auction route, equity investors in aggregate would have saved tens of millions of dollars.

“We expect to see more collateral managers using this feature because it’s simpler and more cost-efficient than traditional refinancings,” Hallenbeck wrote.

Marketing Push

To convince Wall Street to sign onto KopenTech’s platform, the firm is reaching out to brokers, investors, and banks, and speaking at industry events.

The auction, conducted on January 30, was meant to prove how the process can work. TCW Asset Management used KopenTech’s auction platform to refinance the securities it issued in a deal called TCW CLO 2019-1. That CLO featured an unusual provision in its documents known as an applicable margin reset, or AMR, which allows TCW to refinance the securities using an auction.

Read More in This Week’s Credit Brief: Disrupting CLO Underwriting

The AMR provision was invented by Sancus Capital, which owns the riskiest portions of the TCW deal, known as the equity. It has the most to gain from refinancing in auction form.

A CLO might pay around $500,000 to refinance its obligations through Wall Street dealers, plus six-figure fees to lawyers and rating agencies. But total fees to do so on KopenTech’s platform could be closer to around $350,000, or less if a transaction is refinanced more than once. That savings ends up with equity holders like Sancus.

Lower Fees

Some bond investors may not like the online auctions. In a conventional refinancing, they would have the first shot at buying the new, lower yielding securities. In the auction, they would bid like everyone else, and may end up with fewer securities than they had before, or none.

In the TCW auction, five broker dealers got a commission of 0.02 to 0.03 percentage points times the face value of the securities they sold, according to KopenTech. The company said it also charged a 0.02 percentage point commission, plus a $50,000 registration fee, and a $35,000 annual fee for each transaction on the platform. If the same CLO does additional auctions in the future, its costs can be even lower.

The pricing on the refinancing was in line with transactions arranged by banks. The least risky securities that TCW recently issued, those rated AAA, paid 1.07 percentage points more than the London interbank offered rate, down from 1.44 percentage points and at the wide end of the range of recent conventionally refinanced CLO securities.

Efficiency Gains

Some dealers believe that even if this process cuts their profits, it’s so useful to the fund managers that put CLOs together that it will inevitably be more widely adopted.

“The process is so quick and efficient, and it makes sense. It’s a good option for people to have this embedded,” added Adnan Zuberi, BNP Paribas’s global head of CLO origination.

KopenTech’s auction leaves the initial securities intact, simply changing the yields on the instruments, so there is no need to issue new obligations or get fresh credit ratings, saving money on legal and grading fees. In that regard, the refinancings are similar to a repricing for a loan. It was conducted as a Dutch auction, where investors submit their bids for the quantity of securities they’d be willing to buy and the price they’d pay, and the auctioneer sets the prices at the lowest level that will result in all the securities being sold.

The creators say CLO auctions are “disruptive” to the CLO refinancing process similar to how certain Silicon Valley players have upended other industries, but acknowledge its limitations.

“I use an Uber most of the time, but I still use a taxi sometimes,” said Olga Chernova, chief investment officer at Sancus and a chief architect of the feature. The auction is “a tool in the toolbox for very quick, cost-efficient and headache-free execution. But if you want something complicated, you’d get a bank.”

To contact the reporters on this story: Adam Tempkin in New York at atempkin2@bloomberg.net;Lisa Lee in New York at llee299@bloomberg.net

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, ;Natalie Harrison at nharrison73@bloomberg.net, Dan Wilchins, Christopher DeReza

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