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January 2023 | Issue 251
News
CLO managers get dusters out for ‘clean-up’ issuance
CLO managers get dusters out for ‘clean-up’ issuance
Hugh Minch
Senior reporter
As leveraged loan prices recovered some of their value through November, a number of CLO issuers took the opportunity to term out underwater warehouses. Market participants have named the practice of issuing these CLOs the ‘clean-up’ trade, where counterparties accept sub-optimal deal economics in order to focus their attention on new and hopefully better investments.
Not all clean-up CLOs have been forced to print by their bank arrangers but, in some cases, the warehouse financing costs can step up after a 12-month period. For example, the financing rate could jump from Libor plus 100 to 250 basis points or more.
Some managers may prefer to sit in the warehouse hoping that the market improves, but others, which are able to attract senior debt investors, may prefer to move into a term structure.
Discount margins were not disclosed for most of the clean-up CLOs, but the deal coupons suggest off-market prints, and there are rumours of substantially discounted liabilities. One manager is said to have offered a triple A investor 300bp. This has led investors to question whether some of these deals may be uneconomic.
Ian Wolkoff, managing director in Pretium Partners’ structured credit group, says the clean-up deals don’t have sufficient excess spread available for debt investors.
“Clean-up deals don’t have enough excess spread available for debt investors”
Ian Wolkoff, Managing director, structured credit group | Pretium Partners
“Some recent deals have a weighted cost of debt of over sofr plus 300,” says Wolkoff.
Add management fees and expenses to that and there’s very little excess spread available as credit enhancement for the deal.
“So, while you might have 1-2% additional structural subordination to the double B tranche, if you fail an over-collateralisation test, there is limited available cash to delever the transaction, effectively weakening a meaningful structural benefit in primary transactions that is available in secondary transactions.”
If investors opt for a clean-up trade, it may be in the interest of the deal counterparties to complete the term-out before the end of a calendar year. Speaking on the third quarter earnings call for Eagle Point Credit Company in November, Eagle Point managing partner Tom Majewski said bankers are often motivated to “get all their problems off the books by year end”.
“You might as well take all your pain this year”
Thomas Majewski, Founder & managing partner | Eagle Point Credit Management
“If you are a banker, you might as well take all your pain this year, so you don’t have an overhang,” Majewski said. “Your bonus may be down this year, but hopefully, if you cleared the decks, you can start making money again next year.”
Just under 50% of the US CLOs priced in November are clean-up transactions, Creditflux understands.
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Global credit funds & CLO's
January 2023 | Issue 251
Published in London & New York.
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