Libor mismatch gives CLO managers new arbitrage concern

A recent spike in three month Libor has prompted US loan borrowers to switch to the cheaper one month Libor rate, causing a mismatch between CLO assets and liabilities that is putting a new strain on the arbitrage in the structures.

  • By David Bell
  • 16 Apr 2018
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The basis between one and three month Libor is at 44bp, the widest it has been since 2009, according to JP Morgan analysts writing on Friday April 13. Last year the basis was only 15bp, but it has widened as a result of technical shifts in the money markets, they said.

“The combination of increased borrowing by Treasury and the reduced investment by US corporates have been at the heart of the recent rapid cheapening in Libor, particularly in the 3m tenor where there is much more activity relative to the 1m tenor,” the analysts added.

Loan borrowers have been taking advantage of this difference to switch to the one month rate. But many CLO managers, unless deal documents have been amended to permit a switch, have been unable to do the same.

An average of 52% of US CLO portfolios are exposed to assets that are benchmarked to one month Libor, wrote the JP Morgan analysts.

On an annualised basis, that extra 44bp on the liability side has a meaningful impact on equity returns because of the leverage in the CLO structure, which is usually around 10 times. A difference of about 2% on an annualised basis will be seen in the July equity payments, according to Amir Vardi, structured products portfolio manager in the credit investments group at Credit Suisse Asset Management.

This is meaningful, considering CLO equity returns are generally expected in the 12% area. Vardi said he did not expect the mismatch to last long, however, suggesting it would rebalance “at some point over the next year”. 

The JP Morgan analysts were less optimistic of the trend being corrected.

“Though the above drivers have moderated somewhat since quarter-end, resulting in a relatively more stable 1m/3m Libor curve, our short-term strategists believe the curve will likely remain steep going forward as the technical shifts we’ve seen are unlikely to go away anytime soon,” they wrote.

Spreads under pressure

The arbitrage in CLO structures has already been under pressure because of widening spreads on the debt liabilities, caused by both macro concerns — such as the impact of tariffs, tax reforms, fears of trade war, for example — as well as heavy supply.

Three new CLOs were priced last week, from Marble Point, GSO/Blackstone and TCW. The triple-A spreads in each deal were priced at 101bp over Libor, 98bp and 107bp, respectively, off the sub-90bp tights that have been printed this year.

At the junior end of the capital structure, spreads are 35bp wider at the triple-B level since the start of the year and 75bp wider at the double-B level, according to BAML researchers.

The biggest supply pressure is coming from a slew of refi and reset deals, with some market participants concerned that the rollback of risk retention rules will encourage managers to bring more deals to the refinancing market — transactions they might not have bothered doing if they needed to commit capital to do so.

A rush to refinance deals ahead of April payment dates has also encouraged heavy supply in recent weeks, Bank of America Merrill Lynch analysts pointed out on Friday. But as this calms down next month, spreads should tighten again, they argued.

  • By David Bell
  • 16 Apr 2018

GlobalCapital European securitization league table

Rank Lead Manager/Arranger Total Volume $m No. of Deals Share % by Volume
1 Citi 4,296 9 13.65
2 BNP Paribas 3,026 10 9.61
3 Bank of America Merrill Lynch (BAML) 2,411 8 7.66
4 Lloyds Bank 2,213 9 7.03
5 Credit Agricole 2,025 6 6.43

Bookrunners of Global Structured Finance

Rank Lead Manager Amount $m No of issues Share %
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1 Citi 33,892.62 98 11.03%
2 Bank of America Merrill Lynch 30,933.21 87 10.07%
3 Wells Fargo Securities 26,900.77 74 8.75%
4 JPMorgan 23,031.77 69 7.50%
5 Credit Suisse 19,951.44 47 6.49%