Tighter spreads across the capital stack going in the new year have encouraged CLO managers to reprice certain tranches of CLOs. The original rise of refinancings in December was focused on fixed rate tranches, but a strong pipeline has recently emerged to refi floating rate tranches from older deals.
On Wednesday, Sound Point Capital, acting through Goldman Sachs, repriced a class ‘B-R2’ note rated Aa2 by Moody’s at 150bp and a class ‘C-R2’ rated A2 at 205bp. The deal was originally issued in 2016 and partially refinanced in 2019.
Angelo Gordon reset Northwoods Capital 20 through JP Morgan, issuing $270m of senior notes at 133bp. The original deal was issued late in 2019, but closed in 2020. It had a three-year reinvestment period and one year of call protection that has now expired.
Blackstone Credit, MJX Asset Management, TIIA, and Trimaran Capital Partners are other managers that took advantage of tighter spreads to partially refi older deals this week. Bain Capital, CSAM and Benefit Street are on the horizon to reprice deals, according to Deutsche Bank.
“It is mainly a function of where the current triple-A spreads are,” said Taylor Moore, managing director and portfolio manager at Palmer Square Capital Management. “We priced a static deal in January with triple-A at 90bp, while a lot of current refis are wider, in the 95bp-110bp range. Overall, I would expect to see deals refi their cost debt liabilities by 25bp-50bp, maybe even higher for 2020 deals.”
Saving cost on Covid-19 deals
When the pandemic hit, CLO deals adjusted their structures to meet the demand of investors for shorter dated instruments. CLO managers abandoned the common pre-Covid structure with five year reinvestment period and two year non-call in favour of deals with shorter reinvestment windows, or static issues in some cases.
Managers, however, did not want to be held to these structures long term, and included one year call periods. That means the wave of shorter deals that characterised the Covid-19 year, often with triple-A spreads at 200bp or slightly below, will be callable throughout this year. According to Deutsche Bank, 2020 issued deals eligible to refi and reset account for $40bn.
Palmer Square, a very prolific manager in 2020 with seven deals in the US and two in Europe, was among the first managers to return to the market in the aftermath of the pandemic. The firm priced a CLO in May 2020, selling senior notes, rated triple-A, at 200bp over three month Libor and it will probably look to refi or reset the deal this year.
“The triple-A spreads are currently at the tightest point since 2019,” said Moore. Deals issued in 2020 and 2019 “are now in the money”.
Other CLO managers are looking at the maths for opting for the same strategy — in particular, if the spreads continue tightening.
Refi or reset?
While refis are designed to alter the interest rate on CLO liabilities, CLO resets breathe new life into the trust by pushing out the reinvestment period, allowing the manager to purchase new loans for a longer period.
“For deals issued in 2020, it might make more sense to do a reset,” said Moore. “A manager can reset liabilities tighter, extend the reinvestment period, and the equity portion doesn’t have to put additional capital. The issue with older deals printed in 2013-2014 is that they took losses in the underlying portfolio. In order for a rating agency to rate those deals, the equity holder has to put more capital and that could be challenging,” he added.
Tighter spreads incentivise the repricing to lower the cost associated with the largest part of the capital stack, but the tool also provides the option to include a more equity-friendly capital structure.
“There is a strong business case for refinancings, not just to improve pricing but also to improve capital structures and work out loan treatment for more recent deals that closed last year with shorter non-call periods,” said Nathan Spanheimer, partner in Cadwalader’s capital markets group.
The big year of repricing
Refi and reset activity was almost absent in 2020 in both the US and Europe. In the US the volume was $31bn in 2020 and $43bn in 2019, according to Deutsche Bank. Activity is returning in Europe and is taking off in the US. Deutsche Bank estimates $78bn in refis and $115bn in resets this year in the US.
“The CLO market had almost two years of very light reset and refi activity,” said Andrew Ross, senior director and head of investment risk management at Pacific Asset Management. “The large backlog and the attractive market spreads combine to make refi and reset transactions an urgent and compelling opportunity for managers.
“What is driving the CLO market is that there aren’t many places to find yield and that was a big driver around the November rally and as we move into 2021.”