Life insurance policies and annuities are, in a sense, sausages filled with corporate bonds, direct and indirect real estate investments, and other investment instruments thrown in to liven things up. One of the terms that often comes up today is “collateralized loan obligation,” or CLO. Here Erika Morphy of GlobeSt.com, a Thinkadvisor sister publication, talks about how players in the commercial real estate community think about CLOs.
Earlier this spring, Kroll Bond Rating Agency assigned preliminary ratings to a commercial real estate “collateralized loan obligation,” or CLO, that LoanCore Capital Markets was taking to the market.
The CLO was backed by an eye-popping $1.1 billion in first mortgages secured by a mix of 33 properties. The portfolio consisted of multifamily, office, mixed-use, industrial, hospitality and retail assets. For the two or so years prior, commercial real estate CLOs had started to come back to the market.
But the size of this CLO deal — and to a lesser extent, its 24-month reinvestment period — surprised some observers. The commercial real estate CLO market, it had suddenly become clear, was back. Now, as the CLO market continues, to grow it will have ramifications for borrowers and lenders.
This is not to say that commercial real estate CLOs are anywhere close to their heyday before the Great Recession. In 2007 and 2008 issuance was around $35 billion a year.
The first CLOs to appear after the financial crisis arrived in 2016, when between $2 billion to $2.5 billion of CLOs were issued, according to stats from Wall Street investment banks.
Issuance climbed to about $8 billion in 2017.
This year, there are estimates that between $13 billion and $18 billion in CLOs could be issued.
Here’s a primer on how today’s CLOs are different from the CLOs created in the past, and a look at how borrowers can benefit from the return of this financing vehicle.
What Are They
CLOs are a form of securitization.
They do have some distinct differences from the more familiar commercial mortgage-backed security (CMBS).
For starters, there are tax differences: A CMBS transaction is typically done through what’s called a REMIC structure, which allows for the pass through of interest income to the ultimate investors without double taxation.
A CLO is also a pass-through vehicle, butit uses a different tax regime that allows for greater flexibility, among other things.
Why Would A Borrower Care?
Ultimately for end-borrowers, a more robust — or to be more precise, a re-emerging CLO market — means more liquidity especially for flexible and bridge loans.
Borrowers looking for term financing for, say, a 10-year loan for a stabilized property, will usually find it — or their broker will find it — in the CMBS market. CMBS, though, is very much a commodity-type of financing that is difficult to customize. Loans in a CLO, on the other hand, can be restructured or extended. So when a property is in transition — say the building is being retenanted — a loan that is being securitized in a CLO versus a CMBS is likely the better option.
Another difference: with a CLO generally the institution that made the loan is the same one that is servicing it, unlike CMBS. That too, can mean a world of difference to a borrower.