Collateralized loan obligations are increasingly deleveraging as the first major wave of CLOs reaches the end of the typical seven-year reinvestment period. This is occurring against a backdrop of contracting spreads on leveraged loans and a heavy bout of early repayments, causing some managers to face the choice of liquidating the CLO, attempting a refinancing or letting the deals roll off.
Stephen Anderberg, an analyst at Standard & Poor's, noted that a number of CLO transactions originated in 1997-98 when the CLO market really took off. These have reached, or are now reaching, the end of their reinvestment periods. "As the loans in these transactions amortize going forward, the proceeds will generally be used to pay down the CLO liabilities rather than to reinvest in new loans for the collateral pools. For the loan deals, this amortization can happen more quickly than in the bond deals due to the shorter tenors on the collateral," Anderberg explained.
But it is not just shorter tenors on bank debt that is causing the amortization. Bank debt rarely carries call protection and can be taken out more easily. "So much cash is coming into the CLOs from refinancings that many of the 1997 and 1998 vintage deals are deleveraging," said Mike Hatley, managing director of ING Capital Advisors. "The triple-As and in some cases the double-As are being repaid." This is changing the economics of the deal, as the least expensive funding is being paid down. As a result, "Managers need to consider whether the holders of the junior tranches are better off letting the deal continue to amortize, or either calling the deal or refinancing the deal," explained Hatley.
Whether a manager liquidates a deal or lets it roll off mainly depends on how much excess spread the deal is continuing to generate and how long you expect that excess spread to continue, said Hatley. Also, "where you are on a mark-to-market basis on the assets in the deal and whether or not you had a lot of defaulted names in the portfolio that you think will have high recoveries in the future are factors," he added.