A rush of refinancing and resets of U.S. collateralized loan obligations to start 2021 has market analysts already looking at a potential record year in CLO issuance volume.
About $16 billion in transactions have closed in January across 43 new and refinanced portfolios, as managers rush to take advantage of tighter spreads as well as to extend many of the short-term CLOs that were printed in 2020 in reaction to economic uncertainty surrounding the COVID-19 outbreak.
“Refinancings and resets make a lot of sense if spreads tighten in the new issue market,” Jerry Ouderkirk, senior managing director and head of structured credit at Pretium Partners LLC, said in an interview with Bloomberg. “It is wholly appropriate for the CLO manager community to be aware of where new-issue pricing is, and to lock in better terms, to the extent that the market offers it.”
CLO spreads have tightened in the new-issue market, and that allows the portfolio managers to get sweeter terms on deals they already sold. Average spreads tightened further for all CLO tranches, including 10 basis points now pricing at 103 basis points, according to market data from JPMorgan Chase leveraged finance research.
Two new transactions priced Monday: Octagon Credit Investors refinanced its $526 million Octagon 30 portfolio via Citigroup and Assured Investment Management closed on the $406 million BlueMountain CLO XXVIII through Goldman Sachs.
Last year at this time, nine U.S. CLOs totaling $4.1 billion had been priced.
“There’s a fair degree of pent-up demand,” observed David Moffitt, co-head of Investcorp’s U.S. credit management business, in an interview withAsset Securitization Report. “In addition to that, you’ve got a lot of managers that didn’t get deals done last year and to be relevant, you have to be a programmatic issuer.”
In addition, Moffitt said, “I think investors have been starved for yield and there’s a sense of urgency to get back into the market.”
Wall Street has increased estimates for the transactions with Deutsche Bank AG predicting $193 billion – with $115 billion of that coming in resets – and Bank of America Corp. raising its 2021 forecast by $80 billion from November to $140 billion.
The record to beat was set in 2017, when $165.8 billion of the deals were sold, according to data compiled by Bloomberg.
While the recovery in CLOs lagged other sectors such as corporates following the pandemic carnage, the eventual spread tightening to near pre-Covid levels helped to improve the so-called arbitrage – the gap between the interest earned from the underlying leveraged loans and the cost of borrowing to purchase the assets. A healthier arbitrage enhances the economics of the transactions, which makes it easier to attract CLO equity capital to sponsor new deals.
The fast start to CLO issuance coincides with the strong loan-market issuance in the post-election period, said Brett Klein, executive managing director and global head of corporate credit for Sculptor Capital. “That may be because the uncertainty was lifted, as substantially all risk assets have improved,” he told ASR. “However, we need to recognize that specific to loans, the market is beginning to see the floating rate feature as an asset again and the pace of CLO creation are also factors contributing to this strength.”
The pace of demand is also allowing managers to increasingly negotiate for greater freedom in how troubled assets are treated, or acquired, in a portfolio. Multitudes of loan downgrades in 2020 triggered credit-quality and other ongoing performance tests in CLOs; managers also found themselves disadvantaged against hedge funds in competing for low-priced distressed debt assets that were either in default via bankruptcy or downgraded to near-default levels by ratings agencies.
CLOs could not acquire much of such collateral without breaching credit-quality triggers governing portfolios’ collateral performance, such as 7.5% caps on triple-C rated loans.
“This would not permit them to do anything extreme on the risk spectrum, but rather allow managers to do things that might enable them to fortify and protect the deals,” said Sculptor’s Josh Eisenberger, managing director and head of U.S. CLO management.
Exiting Non-Calls
Besides the ongoing tightening of CLO liabilities, the surge in refinancings is also due to the record volume of CLOs exiting their non-call period, Deutsche Bank analysts wrote in a recent note.
About 80% of outstanding deals, worth about $505 billion, will have exited their non-call period by the end of 2021. Of those, about 27% will do so during this year, the bank said. Deals issued in 2020, mostly structured with one-year non-call periods in the aftermath of the pandemic to entice investors, account for $40 billion of this.
Reset transactions differ from refinancings as issuers are able not only to reprice at a lower rate, but also may tweak various features of the existing CLO in different ways, including shortening maturities. CLOs, which securitize bundles of leveraged loans, typically last about four to five years before their managers sell the portfolio, pay the CLO bondholders and give the remaining cash to investors in the riskier equity part of the deals.
Starting in about 2016, CLO resets and refinancings became much more prevalent, as repricing deals and changing terms more frequently can reduce the rates issuers pay to bond investors -- effectively the managers’ cost of funds. Issuers can refinance or reset existing CLOs as many times as they like, if the economics make sense and the deal is out of its non-call period.
Because senior-rated CLO slices have largely retraced all the spread widening experienced beginning in March, attractive relative value can only be found much deeper down the capital structure in new-issue transactions, market observers say.
“CLO BBs and equity are the most attractive now, in terms of relative value,” Tracy Chen, head of structured credit at Brandywine Global Investment Management, said in a Bloomberg interview. “High yield and corporates retraced all the widening, but CLO BB tranches only retraced 65%, so it still has 35% to go. CLO equity is the same story. That’s why there’s value there.”
This story includes reporting from Bloomberg.
