Published in London & New York
10 Queen Street Place, London
1345 Avenue of the Americas, New York
Creditflux is an
company
© Creditflux Ltd 2024. All rights reserved. Available by subscription only.
Analysis CLOs
Static deals stand out in Europe
by Poh-Heng Tan
Over recent vintages, European CLO equity in redeemed deals has usually delivered excellent returns. But managers might be surprised to discover that static deals are the region’s stars
Based on our sample of 75 European CLO deals that have either already been redeemed or are expected to be fully redeemed soon, the performance of CLO equity tranches from the 2020, 2022 and 2023 vintages stand out.
CLOs from these years delivered impressive final IRRs supported by strong equity NAV metrics. As shown in table 1, their average equity NAVs exceeded 100%, highlighting their robust performance.
In our sample, the equity performance of static deals in particular was remarkable. Most that have been redeemed thus far capitalised on the pull-to-par effect by taking advantage of loan market volatility.
European CLO equity IRRs by vintage (%)
Source: Intex, CLO Research
For example, the one deal from 2023 in the sample was a static deal. It posted an equity IRR of 35.9% and an average annual distribution of 28.9%. Its solid annual distribution is unsurprising, as the deal paid out excess par, delivering a total distribution of 13.2% on its first payment date.
These static deals typically purchased their initial portfolio at a discount. The average IRR across them was 34.6%. In addition to achieving a solid final equity NAV, these deals also delivered healthy annual distributions on average. Static deals further benefited from their leveraged structure and low management fees. Table 2 (below) shows the performance of the eight static deals in the sample.
34.6
%
Average IRR across static deals in our sample
Not all principal-driven deals were structured as static deals. One example is Edmondstown Park CLO, which was structured as a regular CLO with over four years of reinvestment. Managed by Blackstone and arranged by BNP Paribas, this CLO also performed exceptionally well, with an expected net equity IRR of 36-37%, based on an assumed issue price of 95%. This strong performance is attributed to the manager’s acquisition of assets at a weighted average price in the low 90s. The pull-to-par effect, as the loan market rallied, significantly boosted the equity IRR.
Away from principal-driven CLOs, which aim to generate returns primarily through asset price appreciation, rather than ongoing income, the results were more mixed. CLO equity tranches from the 2013, 2014 and 2015 vintages performed reasonably well, with average IRRs of 9.6%, 10.6% and 8.8%, respectively.
Average equity IRRs for 2013-2016 vintage European CLOs (%)
Strong distributions but low IRR
Deals from the 2018 vintage, on average, recorded an annual distribution of 15.1%, but only delivered an 8.3% IRR. Unlike the 2014-15 deals, 2018 vintage deals had a short timeframe, with the average period from closing to the final payment prior to liquidation being five to six years. In contrast, 2014-15 deals were outstanding for seven to eight years on average before being called.
This difference potentially highlights the value of a reset, which extends a deal’s reinvestment period. From an equity standpoint, the longer a deal remains active, the more distributions are received, reducing reliance on the final liquidation value.
Based on the 42 fully redeemed European CLOs from 2013-16, reset deals outperformed non-reset deals in terms of final equity IRRs, on average. However, it is important to note that the sample size remains relatively small, as not many reset deals have been fully liquidated yet. On average, reset CLOs outperformed non-reset deals by slightly over 2 percentage points in IRR.
15.1
%
Average annual distribution of 2018 deals. They delivered an 8.3% IRR
As highlighted in ‘Reset or refinancing?’ (Creditflux, September 2024), the difference between reset and non-reset CLOs is more pronounced in the US than in Europe. This conclusion was based on a sample of 138 fully redeemed deals issued in 2014. In the US, high prepayment rates during the post-reinvestment phase tend to put pressure on a deal’s equity performance.
In contrast, EU CLO post-reinvestment prepayment rates are generally lower than their US counterparts, and seasoned EU CLOs have typically recorded better final equity NAVs on average, which is a key factor for equity investors.
Non-reset deals, or deals with shorter durations, typically rely on their final equity NAV to deliver decent equity IRRs. For a regular CLO, the initial equity NAV is generally in the 80s, but it is expected to decline over time due to credit losses from defaults or trading activity. Therefore, as long as a deal can distribute equity cashflows that significantly exceed the decline in equity NAV, the longer the deal remains outstanding, the better its final performance is likely to be. However, if the equity NAV declines too sharply, a poor final NAV could potentially offset the benefits of additional distributions.
Liquidation timing is crucial
This year seems to be an opportune time to liquidate seasoned deals, as equity NAV metrics have reached levels where further upside is limited, while downside risks are heightened due to strong loan market conditions. Conversely, some deals were redeemed too early, where the additional distributions were insufficient to offset the decline in equity NAV caused by credit losses or less favourable loan market conditions.
This highlights the importance of timing a deal’s liquidation. Over 75% of the deals we analysed were called during strong loan market conditions, with average loan prices at over 97.
Overall, have European CLO managers met the expectations of their equity investors? Based on deals that have already been redeemed or are anticipated to be redeemed, EU CLOs have delivered good performance, with an average equity IRR of 13.0%. This success can be attributed to a combination of factors, including disciplined issuance spurred by risk retention requirements, the resilience of the underlying loan performance, the expertise of the managers, favourable CLO liability costs and attractively priced assets, among others. Whether these low-teen IRRs match up with investors’ expectations is another matter.
Methodology
- An issue price of €95 is assumed.
- Incentive fees are accounted for in calculating IRRs.
- The final equity NAV includes both the last equity distribution and accrued interest.
- Source: Intex, CLO Research
