Investors fear CLOs running into overtime with WAL extensions

Michelle D’souza

Reporter

CLO investors have sharpened their focus on weighted average life (WAL) test and maturity extensions, with one US investor believing many are taking on more duration risk than they realise. WAL tests limit the average life of a CLO’s collateral and influence the time a deal can stay fully invested.

Chris Duerden, partner at law firm Dechert, says WAL and maturity extensions have been a primary focus for many investors in 2021. “We’ve seen triple A investors who are sensitive to loans that mature after the CLO’s overall state of maturity zero in on that tail risk,” he says.

This is not just a US phenomenon. One European CLO investor says WAL has been a sticking point with mezzanine investors, causing primary deals to be delayed. Typically, CLOs extend their WAL limits as part of a refinancing.

Charlotte-based Duerden says extensions are part of the broader conversation the CLO market has been having about asset restructurings and workouts. “CLO managers are reacting in large measure to the dynamics of the underlying loan market, and extensions of the underlying maturity dates in the context of restructurings have been fairly common.

“Managers are trying to gain greater flex”

Chris Duerden, Partner | Dechert

“CLOs provide a certain measure of flex, but once the deal is closed, it’s hard to change provisions — so managers are trying to gain greater flex for things that may come down the pipeline, and the maturity and credit amendment provisions are an important tool in that context.”

The extent to which a CLO can extend its WAL profile is the primary investment risk, says a concerned New York-based CLO investor, who declines to be named. The way the market models securities is to run them to the end of the WAL test before amortising the portfolio securities, says the official. But in reality some reinvestment happens after the end of the reinvestment period.

“One of the main criteria that limits that reinvestment risk is WAL tests and legal final maturity,” adds the investor. He says some flexible CLO structures with a two-year call option have very limited upside, but the downside is commensurate with a 7-10-year bond asymmetric profile in terms of volatility.

“The CLO investor community is not paying enough attention to this — and most of these flexible deals are getting done at the same spread as regular deals.”

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Global credit funds & CLO's

January 2022 | Issue 241

Published in London & New York.