Global credit funds & CLO's
March 2020 | Issue 221
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March 2020 | Issue 221
Analysis CLOs
Making arb work of it
Charlie Dinning
Data journalist
Analysis of CLO ‘arbitrage’ — the difference between the weighted average asset spread on a deal and its cost of financing — suggests that 2019 was a difficult year for CLO economics. As a result, the 2019 CLOs with the best arbitrage were actually 2018 CLOs.
Timing deals so they can take advantage of periods in which the arbitrage is helpful is not easy because CLOs can take around nine months to ramp up. But CLO managers did make the most of tight CLO spreads in Q1, with 49 US deals going effective between January and March, making it the most productive quarter of the year. Sources say that some CLO managers that priced at the back end of 2018 were able to lock in their triple As with Japanese investors just before they stepped back from the CLO market. Others were able to price mezzanine tranches just before spreads took another turn wider. Bardin Hill priced Halcyon Loan Advisors Funding 2018-2 in November 2018 with the CLO going effective the same day as Nassau 2018-II (5 February 2019). Those two deals had the highest day-one arbitrage of any US CLO that went effective last year, with Bardin Hill clocking in at 214.9bp. At the time Halcyon 2018-2 priced, weighted average US loan margins in the primary market were at 381bp, which was the third highest monthly figure of 2018, behind December (428bp) and July (404bp). Meanwhile the rolling average cost of debt on the seven new issue US CLOs that priced around Halcyon 2018-2 was 173.7bp.
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Timing isn’t everything
Timing and, to some extent, luck play a part in pricing CLOs, but some firms have been able to put together portfolios that consistently outscore others by having high loan weighted average spreads (WAS), or by being positioned defensively and thus benefitting from lower financing costs. BlackRock in Europe and Zais, Nassau and MJX in the US have demonstrated the ability to source high spread loans. These managers routinely hit 200bp arbitrage. Vincent Ingato, CLO portfolio manager at Zais Group, says that some managers tend to be close to, or fully ramped at the time of pricing. “This eliminates the negative arbitrage from closing a deal and having large cash balances that earn almost zero interest while accruing interest on the CLO notes which can be in excess of 200bp above Libor,” he says.
Average day-one arb for US CLOs going effective in Q1 2019
Average day-one arb for US CLOs going effective in Q4 2019
A high arbitrage on day one is conducive to high CLO equity payments. All three CLOs that Zais priced in 2018 are averaging annualised payments of 25% or above. MJX and Nassau have also started making big payments to equity for their 2018 CLOs, averaging at least 17% annualised across the five and two US CLOs each manager priced, respectively.
Portfolio managers re-use old formula
Seven debut CLO managers issued deals with four years-plus of reinvestment in 2019. For these firms, the experience of the individual portfolio manager had an influence on the arbitrage they locked in. AGL Credit Management was founded by Peter Gleysteen in March 2019 and his new firm bears some similarities to his previous firm CIFC Asset Management. AGL hired CIFC’s Robert Steelman to serve as CLO portfolio manager and the New York-based firm’s debut CLO had a WAS of 379bp, above average for Q4. Similarly, CIFC had three CLOs go effective in 2019, and all three registered above average WAS. Elmwood Asset Management brought in Adrian Marshall from BlackRock. Unlike the team in Europe, BlackRock’s US CLO team is conservative, and Marshall applied that trait to Elmwood’s CLOs: Elmwood II and Elmwood III had identical weighted average spreads of 342bp, to register day-one arbitrage of 133bp.
Average day-one arb for Euro CLOs going effective in Q1 2019
Average day-one arb for Euro CLOs going effective in Q4 2019
Euro CLO day one arbitrage: WAS (%) vs funding cost (%)
AIG Asset Management and Birch Grove Capital hired portfolio managers from Covenant Credit Partners for their first 2.0 transactions, and both managers had below average WAS. In Europe, Michael Curtis left ICG for MeDirect Bank and adopted a similar strategy to that used at ICG. MeDirect’s Grand Harbour 2019-1 had a WAS of 392bp, while ICG had a WAS of 388bp across two European CLOs last year. Not all portfolio managers bring their old strategy to their new firms. Sound Point Capital Management hired Russell Holliday from Alcentra, and the European arm of the firm looks to be following the US lead with an aggressive portfolio favoured in Sound Point Euro I. The deal’s WAS hit 390bp. Holliday’s old firm, Alcentra compiled a lower WAS on Jubilee XXI of 375bp. CIFC in Europe, led by Dan Robinson, registered lower WAS than Apollo, Robinson’ previous employer. Apollo hit the market average in Q1 and Q3. CIFC European I was 10bp lower than the average in Q4. This year, loan spreads have tightened sharply amid a refinancing wave. This has made it difficult for CLO managers to source collateral. CLO liability spreads tend to lag corporate credit, but over the course of February US CLO triple As have moved from about 130bp to 118bp. One CLO equity investor says that, on the face of it, CLO arbitrage levels are worse than they were in 2019. But equity investors are able to negotiate fee cuts, keeping cash in their deals and keeping equity returns in check.
Multiple of money has been calculated by dividing aggregate equity payments to date by the par size of the subordinated notes.
Multiple of money
We calculated arbitrage based on the difference between a CLO’s cost of financing and asset-weighted average spread. Weighted average spread was taken from a CLO’s first trustee report following its closing date.

For funding costs, fixed rated tranches were converted to floating rates based on floating rate pari passu tranches.
Data was sourced from CLO-i and Moody’s Analytics and includes only US and European BSL CLOs that went effective in 2019 with reinvestment periods of at least four years. Triple C-flex CLOs were excluded.
US CLO day one arbitrage: WAS (%) vs funding cost (%)
quotation mark
In 2019, some CLO managers hoped that good timing would enable them to lock in favourable arbitrage levels, but others opted for aggressive or conservative tactics when building portfolios
Our analysis covers CLOs which went effective last year, and the best of these tended to be deals that priced in late 2018 and were able to finalise their ramp up amid the December 2018 sell off. BlackRock and Nassau Corporate Credit used this tactic most effectively in Europe and the US. BlackRock European VI had a day-one arbitrage of 239.4bp, and US transaction Nassau 2018-II locked in a 217bp differential between its assets and liabilities. Both CLOs went effective in February 2019. On average, US CLOs that went effective in the first three months of 2019 had a day-one arbitrage of 167.5bp over Libor. In Europe the figure was 192.2bp. This was as good as it got, because CLO liability spreads widened faster than loan spreads until Q4. Favourable conditions in the first quarter of 2019 owed much to relatively tight CLO liability spreads, with assets paying just 343bp in the US and 371bp in Europe. The cost of debt for a US new issue CLO with more than four years of reinvestment jumped 22bp in three months from 175.9bp in Q1 to 197.9bp in Q2. In Europe, the jump was slightly less: spreads rose from 178.9bp in Q1 to 189.8bp in Q2 before peaking at 199.9bp in the third quarter.
BlackRock had two European CLOs go effective in 2018, BlackRock European IV and V. BlackRock IV has an average annualised payment of 15% to equity investors and BlackRock V paid 21%. But it is not just sourcing loans with high coupons that can pay off. Some managers prioritise conservative portfolios in order to lock in cheap financing on their CLOs. Kyle Roth, portfolio manager at Allstate Investment Management Company points out that this can also benefit equity investors. “In periods of loan market weakness, a conservative portfolio will outperform others mark-to-market — exhibiting less drawdown in equity NAV and more stable MVOC ratios across the debt stack,” he says. Aimco is an example of this as the firm had four CLOs under management that made an equity payment in October 2019, when the average first lien loan that came to the market was paying only 314bp. All four paid out over 15% average annualised to its investors.