Santander Creates New CLO Refi Structure With Outsized X Tranches to Help Managers With Post-Reinvestment Maneuvers

Santander is reshaping the CLO refinancing market by creating a new structure where an outsized X tranche is inserted into a CLO post-reinvestment, sources tell Octus. The move allows equityholders in the structure to either receive an elevated par flush payment by using the proceeds of the debt tranche to finance an equity distribution, or to pool collateral from multiple post-reinvestment deals without a large equity injection, sources say.

In two deals arranged by Santander, which were refinancings of KKR CLO 23 and New York Life Investment Management’s Flatiron CLO 19, investors saw X tranches being added to the deals at the size of $12 million and $5 million, respectively. The innovation is intended to satiate CLO investors that currently favor short-duration CLO paper, since there is no extension risk and less spread duration and volatility. Sources say that short-duration money has been priced out of three-year reinvestment/one-year noncall CLO refinancings and can theoretically get out of the investment if spreads widen.

While a new X tranche is common in new issues and resets, the addition of the outsized tranche into post-reinvestment deals as part of a refinancing has caused some investors to question the structure, arguing that the excess spread in the deal is being stripped out to elevate returns to the equity when a par flush is done.

“While the triple-A holders are going to remain largely unaffected by the addition of an X tranche, especially if its short duration triple-A paper, the single-A to double-B tranches are going to be negatively impacted as the excess spread for those tranches is being stripped out in favor of the equity.” one CLO tranche investor told Octus.

One CLO structuring banker noted that X tranches are typically issued to avoid having to inject new equity into deals, and that they believed that the equityholders in the NYL deal were looking to cash out upfront, rather than rely on future distributions from the vehicle.

Santander, which began structuring U.S. CLOs in 2024, has been looking for a competitive edge in a crowded market by offering managers new and innovative structures that allow them to find alternative solutions for their equityholders in a tougher arbitrage environment, according to sources.

“While Santander came up with this new structure, it is ultimately the manager’s discretion as to which structure they choose,” a source familiar said. “The pros and cons of different structures are laid out for the manager prior to bringing deals to market, and the bank helps to give them an idea of what different structures mean for their pricing.”

Market sources said that initial price talk was not originally offered on the X tranche for New York Life’s Flatiron 29 refinancing, which is currently in the market, as the bank wanted to receive investor feedback on the structure prior to issuing the deal. The refinancing ended up receiving significant investor interest, sources said, coming in over 2.5 times oversubscribed, with triple-Bs oversubscribed by two times looking to price about 25 bps inside of initial price talk at 250 bps.

While the maneuver may have been penalizing for mezzanine holders, because the deal is a full-stack refinancing, all existing noteholders were paid back at par prior to the new notes coming to market. Since no holders are rolling their stakes, all the new investors in the deal were able to re-underwrite the collateral pool and agree to their participation after the structure had been fully disclosed, sources said.

“If this were existing debt, I would agree that this structure could be considered aggressive, but there are no rollers – everyone got par and they have new debt buying with eyes wide open,” a CLO manager told Octus. “It’s actually pretty creative.”

In an adjacent maneuver, Santander helped KKR pool collateral for its refinancing of KKR CLO 23 using a mix of multiple other post-reinvestment deals. Sources familiar with the deal noted that the pooling of assets allowed the new structure to be treated more like a static CLO deal, where investors were able to underwrite the pool of collateral as if it were a new issue since it contained a consenting set of new participants rather than existing holders rolling their stakes.

“This kind of lumped deal only works when the manager is the majority equityholder in all three deals,” a source familiar told Octus. “The manager is able to issue redemption notices, for example, two weeks prior to the deal, and they are able to line up the liquidation date of the other deals with the closing date of the new deal so that all of the collateral is closed into a single vehicle. The proceeds of the full stack refinancing are used to acquire the other assets from multiple deals. Without the X tranche on KKR CLO 23, the additional equity, which was $9.55 million, would have had to be $12 million larger to acquire the upsized portfolio.”

This new tactic is expected to gain popularity as managers look to combine deals with negative net asset values, or NAV, with those that are positive, in order to offset losses.

“This works well, because some deals may have positive NAV, while others may be negative,” a source close to the deal told Octus. “The combination of all of the deals works because they are all delevering and the excess NAV from certain deals will offset the negative NAV from others. The manager is required to inject significantly less equity using the proceeds of the X tranche to fund the upsize.”

Similar to the par flush payment in Flatiron 19, the noteholders of KKR 23 were paid back at par prior to the refinancing taking place, since the whole capital structure was being refinanced. Sources with knowledge of the matter believe that the full stack refinancing par payments to original holders coming prior to any maneuver from the bank are critical, as the structure is not meant to be misleading, but rather allow managers alternative solutions for their post-reinvestment period deals.

The upsized X tranche is one of a range of strategies being employed by managers looking to avoid crystallizing losses from CLOs with depressed NAVs. Elsewhere, a “mandatory exchange” mechanism, in which a temporarily upsized equity tranche is issued at a steep discount before being exchanged into equity at a more typical size, allowing managers to restructure their CLOs with a lower threshold for equity investor consent, has increased in popularity.