What is Par Flush?
Meet the new twist in the growing and evolving market for collateralized loan obligations.
The CLO market has been positively red-hot. Issuance continues to remain robust in 2018, and we now see risk retention in the rear-view mirror. A new term for CLO investors to be aware of is ‘Par Flush.’ The emergence of the Par Flush feature is not only a function of investors’ demand for CLOs but also of investment bankers’ penchant for using water metaphors to describe deal structures.
What is Par Flush? In a typical CLO, as borrowers make payments, the cash goes to the highest rated bonds tied to the deal. Further payments flow down the waterfall with the equity holders getting the last remaining. Par Flush changes the waterfall structure whereby the portfolio manager can make payments to equity holders in front of the bonds. There is one crucial provision: payments must come from the principal in buying and selling the loans in the portfolio and not from interest payments. The amount is typically capped at 1% of the deal size. Trading gains are usually retained in the CLO to cover defaults and maintain a layer of security for the bondholders. Par Flush was included in only a handful of 2017 deals, but some believe that up to a quarter of new deals this year will include this provision.
Will these changes make investors raise an eyebrow? Only the market will dictate. While demand continues to grow in the CLO space, investors are not generally shunning deals with these structures. Some may encounter repercussions due to fewer protections in a credit downturn, but as Warren Buffet wisely noted, ‘only when the tide goes out do you discover who has been swimming naked.’