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August 2021 | Issue 237
Analysis
CLOs

CLO wormhole opens as deal pricing blurs

Tanvi Gupta headshot
Tanvi Gupta
Head of data journalism
Sayed Kadiri headshot
Sayed Kadiri
Editor
The CLO prints you see today might have happened a month ago. No, we’re not travelling back in time. Instead, a trend toward locking in senior notes a month early is skewing market pricing
European CLO investors can’t believe their eyes. Or, rather, they shouldn’t believe their eyes because a flurry of new CLOs that ‘priced’ in July actually priced the bulk of the capital structure a month earlier.
In an unusual trend, sources say a number of CLO notes, rated triple A down to single A, were locked in late in the second quarter, courtesy of three large investors. It then took up to a month for the full capital stack to print, which means July triple A spreads are probably more reflective of levels from the previous month.
Investors say that the true level for European CLO triple As is 100-102 basis points. However, the July average for these notes has been 95.8bp.
Elena Rinaldi, portfolio manager at TwentyFour Asset Management, says that CLO triple A-rated tranches pricing in triple digits are one of the most attractive investments in structured credit. “That amounts to a return of 1.2-1.3% for triple-A risk — nothing in ABS comes anywhere close to that.”
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Historical European CLO triple A spreads vs current level*
Source: CLO-i * Dotted lines show current spreads for various reinvestment periods based on 1-month term curve
Record issuance in Europe
The one-month delay between the agreement and the pricing day is mostly because of overwhelming supply. €57.34 billion of total issuance has entered the European CLO market this year, smashing the previous full-year record of €45.73 billion (in 2017) by 11 June. But despite massive volume during the first half of the year, the market tightened.
A London-based CLO arranger highlighted that this is because triple A investors had unused budget from last year and because there have been many refinancings where triple A investors did not roll, which means they have even more cash to redeploy into new issues and resets.
There was also a CLO reset gap created at the triple A level, with Norinchukin Bank still absent from the market.
“Nothing in ABS comes close”
Elena Rinaldi, Portfolio manager | TwentyFour AM
Over the past couple of months the resistance has broken down, with triple As leaking almost 20bp wider from 85bp at the end of May. The relatively thin investor base for CLOs versus corporate credit means that the market is prone to bouts of volatility, especially during the summer slow-down and when mezz tranches are small.
“It might only take one or two investors to drop out of a tranche and you are repricing the market,” says Rinaldi.
2020 deals are likely to be reset
Issuance is expected to slow further over the coming months, but 2020 CLO resets are still comfortably in the money. These have an average triple A print of 140.9bp with a short non-call and reinvestment period. One investor points out that 2020 deals are natural reset candidates and price takers. Besides the wide spreads, they were issued with sub optimal leverage and enlarged equity tranches.

But 2019 CLO resets or refis are now difficult to justify, says a European CLO arranger. Sources say there were a few potential 2019 resets in June that were pulled in response to wider spreads.
European CLOs (by pricing year)
Source: CLO-i
In the first three months of 2021, the average reset of a 2019 European CLO shaved 32.9bp off its funding costs. That dropped to 21.1bp in the second quarter and 14.1bp in the third quarter, at the time of press.
60% of 2019 deals which are out of their call locks have now been repriced, according to CLO-i. Those 2019 CLOs out of non-call that have not yet repriced have an average triple A spread of 110bp and a funding cost of 198.79bp.
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Global credit funds & CLO's
August 2021 | Issue 237
Published in London & New York.
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