LONDON, Aug 27 (Reuters) - European Collateralised Loan Obligation (CLO) funds nearing the end of their investing lives are looking at potentially controversial new ways to stay invested in buyout loans to get around restrictions on their diminishing ability to invest.
CLOs nearing the end of reinvestment periods are trying to roll into new buyouts of companies that they are already lenders to without any cash changing hands, which would otherwise have to be returned to their investors.
These ‘cashless rollovers’ are viewed as a legal grey area, particularly when companies are being sold, which could potentially open the funds up to legal challenges by CLO investors that would prefer to be repaid.
The 635 million euro ($849.28 million) leveraged loan financing backing Pamplona Capital Management’s acquisition of French funeral firm OGF is the latest buyout financing to offer existing CLO investors the ability to roll into the deal on a cashless basis.
The practise has already been used on several leveraged loan refinancings, but its use on new buyouts is proving controversial when companies are sold, as change of control provisions usually trigger repayments to CLO investors.
Cashless rollovers have been offered on German metering firm Ista’s buyout in April, when minority shareholder CVC bought the 76 percent of Ista that it did not already own, and on the buyout of German publisher Springer Science+Business Media by BC Partners in June.
Cashless rollovers are not straightforward in Europe due to differing legal jurisdictions, varying company credit agreements and CLO covenants which govern what the funds may or may not do.
OGF’s deal is uncharted territory as it is the first cashless roll sought on a French buyout.
The advantage of allowing existing CLO lenders to roll into new deals for arranging banks and private equity firms is that existing CLO liquidity is kept locked in, which helps to sell deals.
The move has been popular with CLO managers to date which are able to keep cash invested and earn management fees rather than receive repayments to return to investors.
“Most of the bigger funds are now on board for cashless rollovers. If it is done correctly then the borrower and documents do not really change and it is just tinkering around the edges,” one senior investor said.
The move is dividing loan market opinion however, particularly when companies are sold. Some banks and funds think that change of control could lead to legal challenges in the future from CLO investors that would prefer to be repaid.
“It works if it is the same instrument and sponsor, but when this isn’t the case it becomes a grey area.”
A cashless rollover can be done by getting a change of control waiver which is difficult as it can require 100 percent consent from lenders.
It can also be done by amending and extending existing debt and allowing change of control to take place at a higher level in the company’s capital structure. Fronting banks can also be used to act as agent on the deal, which allows funds that want to roll to stay in place without being repaid.
“Some funds will do the deal but are worried as their investors could make a legal case against them. Different funds have different views,” a banker said.
Despite differing opinions, the scheme is likely to continue until significant new liquidity comes from a growing number of new funds or CLOs that are able to invest in new loans.
In August, JP Morgan more than doubled its 2013 issuance forecast for European CLO funds to as much as 10 billion euros from an earlier 4 billion euro target. ($1 = 0.7477 euros) (Editing by Tessa Walsh)