CLO refi volumes set to stress market capacity
A boom in CLO refinancing and reset volumes, alongside intense new issue activity, is leading to worries about whether banks, rating agencies, law firms and other deal parties have the capacity to cope.
As refi and reset activity picks up, observers are readjusting forecasts and predicting a banner year for volumes. Recent market conditions have led Bank of America to almost double its forecasts and warn about market capacity to process a massive volume. Earlier this month, analysts at the bank projected there would be $140bn in refi and resets in 2021.
But following the acceleration of repricing activity this month, they have revised expectations to $250bn.
Triple-A spreads have tightened substantially over the last two weeks. On Tuesday CVC Credit sold senior notes in a new CLO at 105bp over three month Libor, considered right now by bank analysts the benchmark for deals with a five year reinvestment period. Benefit Street Partners on Wednesday refinanced some tranches of a $410m deal, Benefit Street Partners CLO II, originally issued in 2013.
The manager achieved the tightest triple-A CLO refi since 2018, selling the senior notes at 87bp over three month Libor.
But the attractiveness of these spreads is leading to a rush to market, potentially challenging the capacity of crucial market participants such as arrangers, rating agencies, lawyers and even trustees and other deal counterparties.
"We think the key constraint would be capacity issues at banks/rating agencies to process the refi/reset volume," said BofA.
Large numbers of deals are exiting their non-call periods — older deals, but also Covid-era issues structured with a one year non-call.
According to a lawyer, there are already "some capacity issues" in processing the large volume of deals leaving their non-call period. Some CLO managers are making inquiries with other deal parties about their capacity to execute refi requests.
The process for a standard refi could take around three weeks, sources said, while a reset requires a bit more time because it gives new life to the CLO and the optionality to extend the reinvestment period.
There have been $25bn in CLO refis/resets across 58 deals as of February 18, according to S&P, but liabilities costs and investor demand will bring more deals to the market soon.
"We have had a lot of transactions come in," said Jimmy Kobylinski, senior director and analytical manager at S&P. "We still see heavy activity in resets, but the balance over the last few weeks is towards refi."
The intense activity in repricing is comparable in volume with 2018 when $156bn in refis and resets hit the market, according to Deutsche Bank. Since then, however, deals have changed their language.
"In 2018 a lot of transactions had to refi and reset on a payment date and we had huge spikes in April, July, and October," said Kobylinski. "New transactions issued in 2018 and the transactions reset that year changed the language in order to be able to refi and reset on any date. We probably are going to see spikes on the payment date in 2021 because it is logistically easier, but I believe that the repricing activity will be smooth out throughout the year."
Rating agency sources said they had the resources available to handle the likely volume, and would not sacrifice quality for volume.
"We are working on refi and reset, and it is the busiest period over the last year. I would expect the volume dramatically increase compared to the beginning of the year," said Derek Miller, managing director and head of US structured credit group at Fitch Ratings. "Our team is prepared to appropriately address the credit risk and to respond to the market in a timely manner," he added.