A year ago last Friday, the last 'pre-pandemic' CLO was priced in Europe, Credit Suisse Asset Management’s Madison Park Euro Funding XV. The pricing wasn’t pretty, at least compared to the levels that prevailed just a couple of weeks before, but arranger Citi got the bonds away, somehow.
A week after that, there was no hope at all of doing a deal. Prices plunged in subordinated tranches and equity, traders put in hefty margin calls on repo positions, and the market clanged shut. Managers and banks butted heads over warehouse terms, with some choosing to close down facilities, and others agreeing to waive triggers and restrictions in the hope of recovery down the road.
While painful and, at times, scary, the slow rebuild since has encouraged CLO issuance in new directions, and matured the market.
In both European and US deals, managers have sought urgent fixes to their abilities to play in distressed situations — allowing CLO investors to participate alongside funds in new money injections or workout facilities, and levelling the playing field between different loan investor types.
This could have happened at any time since the market reopened after the 2008-09 financial crisis but it didn’t. Low interest rates and low default rates meant few managers saw a need to make a change, and adhering to precedent in deal documentation took priority — CLOs had always been done this way and always would be.
Bankruptcies from Deluxe Entertainment and Acosta in late 2019 focused managers’ minds on the problem, but only the expected wave of restructurings to come among leveraged borrowers once the pandemic hit prompted a wholesale review of structures and limits on new money distressed financing.
Other innovations also followed. In Europe, the pandemic opened the way to the first print and sprint deal, Fair Oaks III, where the manager issues liabilities without first building up assets in a warehouse. Once the CLO debt is out in the market, the sprint to purchase assets follows.
Greater loan trading activity last year — and a secondary market that was mostly still trading below par — helped give a supportive backdrop for the issue, which, admittedly, has not exactly been followed by a flood of imitators. But still, the structure is common enough in the US, and there was no fundamental reason it couldn’t work in Europe, if a manager were bold enough to move first.
Fair Oaks also pioneered using delayed draw tranches — those included in the docs but not the deal so they can be printed at a later stage if desired — to ease the cost of getting a deal away while mezzanine markets were still disrupted. Necessity proved the mother of invention when the pandemic struck: Fair Oaks only had one euro CLO outstanding, so had little capacity to participate in the recovering loan market without bringing in more assets. More established managers with multiple vehicles in their reinvestment periods could play it safer.
But again, it was new and important. Palmer Square, noted for its unusual approach of executing static CLOs — those with fixed collateral throughout the life of the deal — brought the structure to Europe. Investor certainty about the asset pool usually means tighter pricing.
More innovations followed. Several firms are competing to push the boundaries of ESG investing in CLOs, trying to balance rigorous portfolio scrutiny and exclusions with maintaining a diverse and flexible asset pool.
Even something as basic as CLO maturities were shaken up, to good purpose, by the pandemic. Standard structures since the reopening of the European market in 2013 had been two years of call protection and four years of reinvestment period, with refi or reset optionality baked in.
But the pandemic pushed investors to look to shorter term assets, with more portfolio certainty, while managers proved reluctant to lock in expensive liabilities for the long term. One year call protection was the typical choice of 2020, with reinvestment periods of two, three or four years. The cookie cutter pre-Covid approach was dead.
Last week, however, Sound Point pushed its reinvestment period out to five years — an entirely new departure for Europe, though again, common in the US. The longer tenor made little difference to pricing, with the tightest triple-A print for three years, and may have helped ensure a strong and diverse book for the equity tranche.
An extra year of reinvestment period is hardly a revolution, but it signals a more mature market, and underlines how the market is using the rebuilding process after the worst of the pandemic to try new approaches and vary long-established structures.
A stronger, deeper, and more diverse market should result, thanks in part to the clean-up that the pandemic chaos spurred.