Europe’s corporate loan market is in the midst of a refinancing boom, and this is increasingly compelling the region’s CLO managers to ask their investors for more time to repay principal.
As in the U.S., collateralized loan obligations are among the biggest investors in European leveraged loans. These investment vehicles issue bonds and use proceeds to acquire portfolios of loans. As the loans in these portfolios are refinanced, extending their maturities, the CLOs are running afoul of covenants designed to safeguard bond investors.
One of these is a weighted average life covenant establishing the period in which bondholders can expect note principal to be paid off. Managers attempt to match this to the weighted average life of their portfolio assets, typically seven- and eight-year loans. (Unlike U.S. CLOs, European CLOs can hold corporate bonds as well as loans).
In a report published Tuesday, Fitch Ratings noted that European CLO managers who refinance their own deals are increasingly using the opportunity to lengthen the benchmark weighted-average life. This allows them to correct the imbalance between the original maturity levels of their notes and that of the loans in their portfolios.
The challenge in meeting WAL tests “has become one of the most constraining factors for reinvestment in European CLOs,” the report stated, and is “leading CLO managers to extensively reset their earlier transactions or extend the WAL during a refinancing.”
“Managers have...sought to lock in better financing conditions for longer by extending the WAL covenant to 8.5 years and in a few instances to nine years,” the report added. In some instances, deals that are “performing well” are earning automatic six-month extensions of the WAL test figure when the non-call period ends.
CLO managers in Europe as well as the U.S. have been increasingly challenged to maintain WAL covenants due to the extensive 2017 loan refinancing wave, in which speculative-grade corporate borrowers get lower terms and extend maturity dates on their loans (some loans have refinanced multiple times).
Unless a CLO later refinances or trades into more shorter-duration loan investments, the deals’ amortization schedule may trigger a breach of the WAL test, which would force managers to seek out hard-to-find short-term loans that better match a deal’s WAL standard. Many of those shorter loans are of dubious quality, which might negatively impact a deal’s asset-quality requirements (such as restrictions on the percentage of C-rated loans).
Some managers are gaining their leeway outside of their refi windows. Last month, Blackstone/GSO Debt Funds Mgmt Europe Ltd. renegotiated additional 15 months on their WAL covenants for two of its European CLOs that were refinanced earlier this year.
Blackstone and trustee Citibank signed an agreement in September extending the WAL covenant on Phoenix Park CLO, a 2014 vintage portfolio, to October 2023 from the July 2022 date established during the issuance of refinancing notes in January. It also similarly extended the WAL test benchmark on its Castle Park CLO to March 2024 from December 2022, four months after refinancing that 2014 deal.
According to Thompson Reuters LPC, more than €11.6 billion in euro-denominated CLOs have been refinanced and reset this year through September, out of a total outstanding market size of €70 billion. Last year through early October, only €12.1 billion in total European volume (new-issue and refinancing) had been issued to investors.
The volume of refinanced European loans (in euros and pounds) equaled US$87billion for the first half of the year, according to Thomson Reuters, compared to US$33 billion worth in the first six months of 2016.