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Look for more even CLOs with short reinvestment periods

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Nearly one-third of CLOs issued this year backed by broadly syndicated leveraged loans feature abbreviated reinvestment periods. This is partly because managers are seeking ways to lower their funding costs. Spreads have been slow to recover from the market turmoil late last year, but investors are willing to accept a narrower spread in exchange for tying up their money for less time.

Turns out investors have their own reasons for prefer deals with shorter reinvestment periods, too.

JPMorgan surveyed 53 clients this month who invest in AAA-rated tranches of collateralized loan obligation; 44% indicated that they prefer deals with reinvestment periods of three years or less; just 22% preferred deals with the more standard four- and five-year reinvestment periods.

This suggests there are likely to be more deals with short reinvestment periods in the works.

For the year through March 15, 13 CLOs with reinvestment periods of one, two or three years have priced, according to Deutsche Bank. Most recently, Golub Capital priced a $408 million BSL CLO transaction with a two-year period.

PGIM Fixed Income, Voya Investment Management and Jefferies are among CLO issuers in 2019 who have gone to market with just a one-year duration in deals for reinvestment.

In February, Wells Fargo published a report speculating that managers who issue deals with short reinvestment periods and short noncall periods (from six months to one year) may hope to obtain even more favorable AAA pricing by refinancing the deals once market conditions improve.

Last week, the average spread on the AAA tranches of new-issue CLOs was 138 basis points over three-month Libor last week, according to Deutsche Bank. That is more than 10 basis points wide of December’s average spread and 40 basis points wide of the year-earlier average.

Among survey respondents (who were polled during the week of March 15-19), the average expected AAA note spread they expect to receive at year's end is 134 basis points. That is close to JPMorgan’s own end-of-year projection of 135 basis points for senior-note CLO paper; but the investors' average was culled from a wide berth of various ranges.

A leading 28% see a range of 130 to 140 basis points as the most likely scenario. Another 22% see spreads narrowing into the 120-130 basis point range, the same number who think average spreads will widen into the range of 140 to 150 basis points. Another 20% think rates will exceed a spread of 150 basis points.

Only 8% see spreads narrowing to mid-2018 average levels below 120 basis points.

The survey indicates that some investors are still favoring long-term CLOs, including 13% who are most attracted to deals with extended noncall periods (the report did not designate a particular length they preferred). Another 13% said their preference in the current spread environment was in CLOs with static loan pools, in which no reinvestment is allowed.

Another 3% said they would prefer to purchase the senior notes of a CLO backed by loans to small and medium-sized companies. These are typically sponsored by direct lender using loans originated in-house and previously held on balance sheet.

Another 3% prefer “junior” AAA notes which offer wider spreads from a riskier, lower payment-priority position in a deal’s capital stack.

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