U.S. collateralized loan obligations are likely to see their reinvestment periods extended this year as deals roll into new transactions after being called in full, according to Barclays.
Typically, holders of the junior most CLO securities, known as the “equity” holders, have the right to call a deal after two years and will do so by essentially repricing the deal if debt financing levels are more favorable than when the deal originally priced.
The impetus for calling CLOs normally comes from spread tightening on the senior, triple-A rated tranches. These are the largest tranches of deals, typically representing 60% of the capital structure, and in some cases they are the only class of securities that can be called.
And while many deals issued in 2012 are approaching the end of their non-call periods, spreads on the triple-A tranches of newly priced deals are essentially unchanged from 2012 levels, muting incentives to call deals.
Instead, the incentive comes from spread compression on mezzanine tranches, both the triple-B and double-Bs. Spreads on the mezzanine tranches of new deals are 100 basis points tighter, on average, than they were in 2012.
As a result, the weighted average cost of liabilities is almost 15 basis points lower. This could lead many more deals to be called than when looking at triple-A spreads alone, according to Barclays.
“The market implication when deals are called in full is that their reinvestment periods are likely to be extended if they are rolled into a new transaction,” analysts stated in a report published today. “This should be a slight positive for the market, since one-quarter of the 2012 deals had a reinvestment period of only three years, whereas 2013 and 2014 deals have extended that period to at least four years.”
However, if only the mezzanine notes were re-priced, the effect would be more muted.