CLO resets poised to return despite wide liability spreads

Hugh Minch

Senior reporter

CLO onlookers are heralding the return of resets in 2023 in a boost to CLO primary market forecasts.

Resets renew the lifespan of a CLO by lengthening the deal’s non-call and reinvestment periods, while also refinancing the transaction’s liabilities. These types of deals fell by the wayside in 2022 as CLO liability spreads sky-rocketed.

While resets typically command lower fees than the new issue market, their absence was felt most strongly by banks and other industry service providers in 2022.

The wider spread environment that put CLOs out of the money for most of 2022 still continues, despite the record pace of spread tightening seen in January. A CLO candidate for a reset is likely to have an existing triple A spread around 130 basis points, while the primary market still commands a first-pay spread upwards of 175bp at the tightest.

However, 2023 will see around 40% of the outstanding CLO market leave its reinvestment period, according to research from Bank of America.

“You don’t want to be stuck in a static deal”

Edwin Wilches, Managing director | PGIM

“In the throes of dispersion and volatility, you don’t want to be stuck in a static deal,” says Edwin Wilches, managing director at PGIM and co-head of the firm’s securitised products team.

“Your cost of capital is going to go up, but depending how you structure the deal, if you can capture five points on the loan rebound, and a little more on volatility, I think that’s your better risk-adjusted trade than just doing a new deal.”

Wilches adds that the alternative — liquidating an existing transaction and relocating the assets to a new CLO — would be less attractive in a market where loan NAVs remain heavily discounted.

“You can’t really call the deal because the liquidation value is not there,” he adds. “You could, however, see loans going from 95 to par in the next year or two.”

In the US, no resets of deals backed by broadly syndicated loans priced outside of the first quarter in 2022, while at the same time middle-market CLO reset volume fell to just $2.6 billion from Q2 to Q4.

The same period for 2021 resulted in $77.9 billion resets of CLOs and $13.9 billion of mid-market resets.

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Global credit funds & CLO's

February 2023 | Issue 252

Published in London & New York.