“We’re massively seeing corporates switching to semi-annually,” says a London-based CLO manager. “The problem is that it creates an uneven distribution profile for CLO equity investors as the payments could go from lean to heavy from one quarter to another. I would expect most CLO managers to counter the mismatch and switch liability payments on July payment dates.” After the 2008 financial crisis, European CLOs were fitted with frequency switch mechanisms, which permit a CLO to accommodate semi-annual payments on its assets by aligning the payment profile of its liabilities. European CLO documents lay out objective and subjective criteria through which a frequency switch can be executed, says David Quirolo, a partner at Cadwalader in London. “There is quite a bit of variation among deals. Generally, the objective criteria stipulates that more than 20% of the collateral has reset to pay less frequently than quarterly and that the CLO’s performing senior interest coverage ratio (after taking into account the resets) is forecast to be less than 100%, often with a buffer. Both conditions must be satisfied.”

Quirolo adds that, in some deals, CLO managers can make the switch at their discretion, although the performing interest coverage ratio with the reset assets included would still typically need to be at least 100%. “It’s helpful because objective criteria can be difficult to clear even when a CLO’s portfolio is trending towards semi-annual payments,” he says. Switching payments for CLO liabilities to every six months creates an operational issue for investors, particularly for those which have funds set up on the expectation of quarterly distributions, which are relayed to their own investors on a quarterly basis. A European CLO manager points out that family offices and high net worth investors — which are trying to manage cashflow — care more about the switch than institutional investors. Receiving payments every six months instead of three does not have a major impact on the amount received because of the negative interest rate curve for three and six-month Euribor. A European CLO debt investor said that, for a 5% coupon, quarterly payments would compound to 5.095%, while semi-annual payments compound to 5.062%. Corporate chief financial officers are said to be switching to semi-annual payments to conserve cash during the crisis caused by the coronavirus. One CLO equity investor says: “Changing payment frequencies feels like papering over the cracks. If there is a fundamental concern, switching payments will have a marginal effect.”