The upward trend that has run through European leveraged finance markets in Q1 2021 and into Q2 2021 is also evident in the collateralized loan obligation (CLO) market, with new issues as well as CLO resets and refinancings surging year-on-year.
New CLO issuance totaled €7.8 billion in Q1 2021—a 35% year-on-year increase and the best quarter for new issuance since Q2 2019, according to data from Debtwire Par. The year-on-year improvement in CLO resets (which reprice the debt in existing portfolios and extend deal reinvestment periods) and refinancings (which maintain maturities but lower the spreads payable to investors) was even more profound.
CLO refinancings totaled €8.3 billion in Q1 2021 versus none in Q1 2020, while resets increased to €9.8 billion from only €790 million over the same period last year.
Analysts now expect resets and repricings for 2021 to massively exceed initial forecasts, reflecting continuing demand from investors matched with the continuing strong supply. Both are due to the 2020 backlog, which is now further boosted by the short one-year non-call deals from 2020 that are coming on line for refinancing.
Morgan Stanley now estimates up to €50 billion of CLO refinancings and resets in the European market in 2021, up from the €15-20 billion estimate in its 2021 Outlook.
The CLO activity in Europe through the first three months of the year stands in stark contrast to the situation that faced European CLO managers a year earlier. About a tenth of the loans held in CLO portfolios at the time were either downgraded or put on notice of downgrade by credit ratings agencies.
At the same time, banks providing “warehouse” credit facilities (used by CLOs to buy up portfolios of loans prior to packaging them into tranches and selling to investors) put new lending activity on hold as investor appetite dried up.
The subsequent recovery of the leveraged loan market has turned the tables, with CLO managers now holding onto attractively priced assets in a market where investor demand is outstripping supply.
CLO managers take advantage
As has been the case in leveraged loan and high yield bond markets, where abundant liquidity and excess demand from investors to deploy capital has pushed the cost of debt lower, CLO managers have been able to take advantage of tightening liability spreads to drive refinancing and reset activity levels.
CLOs pursuing refinancing deals have been able to lock in attractive, low prices for the highest rated AAA notes as well as further down the capital stack.
CLO manager Alcentra, for example, closed a €329 million refinancing deal for its Jubilee 2014-XII with pricing at 60 basis points across its AAA notes. Cairn Loan Investments achieved the same pricing in the €271.85 million refinancing of its Cairn CLO IV, and Ares refinanced the AAA tranche on its Ares CLO VI vehicle at 61 basis points.
These are perfect examples of the tighter pricing available on shorter-dated reinvestment periods—the limited period when a CLO can reinvest loan proceeds from its portfolio into new assets. The Cairn and Ares deals have reinvestment periods ending in April 2021, while Alcentra’s reinvestment window will close in October 2021.
Pricing on reset deals has been higher, but CLO managers in these transactions have been able to lock in longer reinvestment periods. Both Oaktree’s Arbour CLO IV and Alcentra’s Jubilee-XXI priced their resets at 79 basis points for AAA tranches—the tightest spreads recorded in Q1 2021 for CLOs with reinvestment periods of four years or longer.
Some CLO managers have been able to negotiate extended reinvestment periods in exchange for higher AAA tranche pricing. KKR priced the AAA tranche for its Avoca CLO X at 83 basis points, but secured an almost five-year investment period. Prior to Avoca, no deals with five-year reinvestment periods had priced since 2019.
Upsizing CLOs is also expected to become a more dominant theme as more CLOs exit their non-call periods. Redding Ridge Asset Management’s RRE 1 Loan Management CLO, for example, was upsized from €451.8 million to €602.54 million, with the AAA tranche pricing at 82 basis points and a reinvestment period closing at the end of April 2025.
CLO documents also now feature improved flexibility to enable CLOs to more actively participate in restructurings, and while CLOs are designed to remain as par focused investors, the structures continue to evolve, adjusting smoothly to new market dynamics (and regulatory dynamics) as they have throughout the history of the CLO market.
The continuing rise of ESG CLOs
ESG negative screening criteria are now widespread and will soon be ubiquitous in both new CLO issuance and in resets. Q1 2021 saw continued evolution of the ESG provisions in CLOs with a step change seen in the market with Neuberger Berman’s €307.3 million Neuberger Berman Loan Advisers Euro CLO I DAC, which was the first CLO to include objective reporting on ESG assets based on global standards (including the United Nations Sustainable Development Goals).