The slowly reviving collateralized loan obligation market is getting a boost from an unexpected source: one of the biggest financial blowups in history.
Lehman Brothers reached an agreement last week with WCAS Fraser Sullivan Investment Management to run a portfolio of approximately $5 billion of commercial loans.
Fraser Sullivan would transfer approximately $3.6 billion of the loans into a series of collateralized loan obligations.
The deal, which was filed with the U.S. Bankruptcy Court in Manhattan July 27, would generate between $1.6 billion and $2 billion for the Lehman estate and its creditors.
The first CLO, backed by at least $500 million of loans, would be issued within six months of the court's approval of the asset management agreement; a second deal, also backed by at least $500 million of loans, would be issued within the first year.
Fraser Sullivan would serve as portfolio manager for the remaining $1.6 billion of loans that Lehman has determined are ineligible to be sold into the CLOs, either because they contain unfunded commitments, the borrowers' credit ratings are below certain levels, or the loans permit borrowers to capitalize interest payments, among other reasons.
Judge James Peek of the U.S. Bankruptcy Court for the Southern District of New York will hold a hearing on the proposed transaction on Aug. 17.
"Commercial loan market conditions have significantly improved, and the market values of many of the loans in the commercial loan portfolio have similarly improved from the historic lows that existed shortly after [Lehman's September 2008 Chapter 11 filing]," Lehman said in the filing.
The failed bank expects many of the commercial loans it holds to be repaid upon maturity, but some 30% are not scheduled to mature before 2016.
Securitizing lets Lehman accelerate distributions while maximizing the value of the assets, the filing said.
"The economic benefit Lehman and its creditors will receive from the receipt of such cash in advance of the normal runoff of the loans based on their maturity schedules exceeds the anticipated costs associated with the CLOs," Lehman said in its filing.
The firm considered other options for monetizing the commercial loans, including selling the individual loans or entire portfolio, but it determined that doing so in a short period of time would adversely affect the values.
Lehman considered using the portfolio as collateral for a bank loan, but the two banks it held discussions with were unwilling to lend by securitizing the assets.
Lehman said it will retain 100% of the equity in the transactions, "thereby preserving upside of the CLOs." Lehman said there is ample authority under Section 363 of the U.S. Bankruptcy Code for the approval of the asset management agreement and proposed sale of a portion of the portfolio to a CLO issuer.
The commercial loan portfolio includes $5 billion of funded and $1.5 billion of unfunded high-yield and investment-grade corporate loans, special purpose vehicles and junior debt, as well as equity securities obtained through restructuring.
