Corporate issuers continue to take advantage of cheap rates by refinancing their existing loans. According to the Bloomberg leveraged loan database, U.S. institutional leveraged loan issuance in the first quarter of 2017 totaled $249 billion. However, 82% of this issuance was in the form of refinancings, rather than new money. The consumer-cyclical, communications and consumer non-cyclical sectors represented the bulk of the refinancing activity. This refinancing wave is a boon for corporate issuers as they seek to reduce their cost of debt, but it leaves investors with less carry. Investors wishing to maintain exposure to the refinancing issuers are left with reduced future interest cash flows. Other investors have instead chosen to reduce their exposures to those refinancing issuers, and their cash balances have grown as a result.
Collateralized loan obligations (CLOs) have historically accounted for roughly 50% of the demand for leveraged loans. The refinancing wave in leveraged loans is having an impact on CLO performance, as well. In CLOs where the active management phase has ended, these loan refinancings have translated into increased paydowns and higher cash balances. This is shortening up the weighted average lives of these securities. In CLOs where the collateral manager is still reinvesting cash flows, sitting on large cash balances can introduce cash drag and diminish excess spread, which funds cash flows to the equity holders. However, leveraged loan prices are at three-year highs, making the redeployment of cash flows into tight spreads less attractive. This has an impact on CLO new issue as well, as a collateral manager would be purchasing loans at historically rich prices in order to ramp a new portfolio.
As corporate issuers continue to reduce their cost of debt through refinancings, they will be poised for future growth. Cash flows that would otherwise have gone to debtholders can now go to building their businesses. This refinancing wave is expected to continue through the second quarter of this year based on corporate needs and the amount of outstanding debt that is able to be refinanced. The effects on investors in CLOs and leveraged loans are both positive and negative, depending on the nature of the investor’s exposure to leveraged loans. However, regardless of how investors are exposed to refinancing risk, the relevance of analyzing the impact of refinancings has become much more significant in the overall relative value framework.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
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