Why the Use of CLOs Is Growing—and Why They Might Be Right for You

For nonbank CRE lenders seeking to manage their cost of funds, a collateralized loan obligation (CLO) could be an excellent alternative.

Utilization of CRE CLOs has grown significantly in the past few years. After 2016 saw around $2.5 billion in CRE CLOs, that number jumped to $7.7 billion in 2017 and is currently projected to hit between $13 billion and $15 billion for 2018.

There are several reasons for this astounding growth and for why your company should consider CLO’s as an alternative funding vehicle.

“A lot of it boils down to a lower cost of capital, in terms of getting better pricing than they would from, say, a warehouse line or a repo line in terms of rates and/or the advance rate you can achieve,” said Michael Dillon, managing director, Servicing at Trimont Real Estate Advisors.

 CLOs also offer an alternative channel to financing, allowing lenders more options to manage their cost of capital.

 “There have been times, even in the last five years, where the warehouse and repo lenders have kind of disappeared,” Dillon said. “If you had been originating your loans with the expectation that you could put them on a repo line, some of that market dried up around 2013 or 2014. So having another channel, another avenue, in which to add leverage to your portfolio becomes attractive.”

“The goal is to have multiple prongs to your overall capital structure,” said Trimont’s Director of Asset Underwriting and Advisory Charles Citro. “You want multiple channels, whether it’s warehouse/repo financing or CLO, securitization financing, so you’re not beholden to any one source of capital. Given what we’ve seen when capital recedes, prudence necessitates diversity.”

For companies on the cusp of greater things, a CLO under the right circumstances can also be a brand builder.

“For platforms that haven’t issued before, CLOs can be a great way to build a presence or brand with the investor base in the capital markets,” Missy Dolski, Director at Varde Partners, said at a recent Trimont-hosted seminar, “Return of the CRE CLO; What You Need to Know.”

That said, CLO’s are not for everyone. A CLO is a tremendous undertaking, requiring around four-five months and the combined efforts of attorneys, banks, underwriters, ratings agencies and data managers, among others. According to Dillon, the current average CRE CLO has increased in size to an average size of $627 million in 2018.

There is a number of factors to consider for determining whether a CLO is right for your firm from cost to the nature of your loans.

“Companies should look through their portfolios to determine whether they have enough duration on their loans to make sense of the effort and the cost,” Citro said. “You need to have enough call protection in order to get enough duration out of the loans to make this exercise workable.”

When the circumstances are right, CLOs can be a profitable and worthwhile vehicle.

“If I have a repo line with a maturity date coming up, that maturity date might not coincide with the maturity of the underlying loans that are pledged to that line,” Dillon said. “That’s an additional thing that will have to be managed by the originator. The CLO gives you financing that’s matched to the termination of each of your individual loans. That’s another reason firms do it.”

For more information on whether a CLO is right for your firm, contact Trimont Real Estate Advisors at (212) 981-6200.