Babson to sell $492.25 million CLO; mezzanine tranches tighten; CLO covenants weaker

By Cristal Cody

Tupelo, Miss., May 3 - New leveraged loan collateralized loan obligation issuance in the weeks ahead is expected to include a $492.25 million CLO from Babson Capital Management LLC, a familiar issuer in the market with two CLOs priced in 2012, according to informed sources.

A CLO offering in 2011 was the global investment management firm's first CLO transaction since 2007.

Babson manages a total of 53 collateralized debt obligations, including CLOs.

In the upcoming deal, Babson CLO Ltd. 2013-1 is expected to price $492.25 million of notes due April 21, 2025, which include $292.25 million of class A senior secured floating-rate notes (Aaa); $65 million of class B senior secured floating-rate notes; $38 million of class C deferrable mezzanine floating-rate notes; $24 million of class D deferrable mezzanine floating-rate notes; $22 million of class E deferrable mezzanine floating-rate notes; $9 million of class F deferrable mezzanine floating-rate notes; and $42 million of subordinated notes.

Merrill Lynch, Pierce, Fenner & Smith Inc. is the underwriter.

Springfield, Mass.-based Babson Capital Management will manage the cash-flow CLO.

The transaction is expected to close on June 4.

Spreads tighter

CLO spreads in the primary market in single-A through BB tranches have tightened, while mezzanine tranches rallied in April and into May, sources report.

"For a time period on double B tranches, typically the lowest rated tranche, there were deals getting done in late March when the pipeline was really thick and heavy in the 650, 675 [basis points] area," one market source said. "Deals are getting done now at Libor to 600 [bps], so it's definitely tightened more in mezzanine tranches."

The CLO mezzanine market was pulled tighter as other risk assets rallied and investors moved to CLO mezzanine tranches due to the higher yield, Dave Preston, senior analyst at Wells Fargo Securities, said in a research note.

"BB and BBB tranches are generally tighter by 50 bps, and some tranches have tightened more than that," he said.

The tightening loan market also may be leading more investors to project an uptick in CLO redemptions, Preston said.

Covenant-lite volume rises

Covenant protection for CLOs has been weakening as volume rises, though little near-term risk for senior secured loans is expected, Moody's Investors Service said in a research note.

"Cov-lite loans accounted for about 40% of institutional issuance in first-quarter 2013," Moody's said.

Covenant-lite loans reached a volume of about $78 billion in the first quarter, 63% higher than the previous high in the second quarter of 2007, Moody's said.

Moody's said significant subordination can mitigate losses on loans, which are first absorbed by subordinated debt and insulate more senior debt.

"For the senior-secured loans that constitute at least 90% of CLO collateral, the absence of traditional covenants has had no material impact on recovery rates," Moody's said. "Rather, adequate cushions of junior debt have led to recovery rates that are little different from those for senior instruments. By contrast, recovery rates for junior debt in cov-lite structures have been significantly worse than those of their traditional-covenant counterparts."

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