Fitch on the Money About Standardized Definitions for CLO’s

Late this week, Fitch Ratings issued a short statement arguing that more standardization of both defined terms and structural components would have a meaningful impact on drawing more investors into the CLO asset class.

The logic is straight forward.  They rightly point out that throughout the life of the CLO market, each deal has been written in its own code” and with very specific structural components.  The intent has been to customize each transaction to the needs of the initial holders (and the asset manager).  We would argue that definitions for key terms in CLO structures are typically “reverse-engineered” to meet the needs of the structure.  As a result, investors are left to study each transaction very closely, as they cannot take any terms that may seem similar or even the same, from deal to deal, to actually carry the same meanings.  Fitch  points out that this makes for an inefficient market and their recent survey of CLO investors seems to indicate that this lack of consistency is putting a damper on investor participation.

We would agree completely with the idea of trying to establish some consistency in the definitions for several key terms that can be found in most or all CLO agreements.  We are less sure about the idea of trying to bring more consistency to structures.  In our view, one of the reasons that CLO’s are attractive to issuers and investors is the ability to customize each structure to meet the mutual objectives of sellers and buyers.

We can look back at the development of several other securitization structures over the years including RMBS, CMBS and several classes of ABS and point out that over time these structures did benefit from an increasingly consistent use of key terms and definitions.  We would point out that these benefits did not accrue only to the investors, as firms developing analytical software for collateral testing, bond trustees and of course, the rating agencies themselves, all benefited from more consistency and standardization of key terms in these other structures.

Given the relative “boom” in CLO issuance during the first half of 2012, Fitch’s commentary is well-timed.  Perhaps the American Securitization Forum can get behind such an initiative and begin to pound out some useful standards for defined terms for CLO agreements.

About markferraris
Managing Principal Orchard Street Partners LLC

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