This week’s chart shows broadly-syndicated loan (BSL) collateralized loan obligation (CLO) primary market issuance for 2018 year-to-date. The stacked bars demonstrate how the different types of CLO issuance contribute to the overall primary market issuance each month. Traditional refinancings, where the cost of debt is reduced without extending the deal, continue to be less prevalent than regular way and reset issuance. A reset is when the cost of debt is reduced and the deal is extended for a certain period of time. Another element of additional flexibility in CLO redemption timing has been the creation of a new type of CLO issuance called the “reissue.” Before this type of issuance became popular, many CLO documents included clauses that prevented refinanced CLOs from being refinanced again. This gave investors a false sense of security as to the likelihood of an earlier call on these types of structures. Once again, CLO equityholders devised an innovation to get around this restriction. Initially referred to as a “call and roll” strategy, the reissue involved the equityholder calling the deal in its entirety, and then rolling most, if not all, of the collateral from the called deal into a new deal, thereby getting around the restrictive language of “no further refinancings allowed.” Note that in this week’s chart the issuance of this reissue type has now become commonplace and a somewhat material, although the smallest, portion of overall CLO issuance.
It was previously commonplace that a CLO could only be redeemed on quarterly payment dates. The large number of resets announced in March and June were to prepare for the April and July payment dates, which were coincidentally very common quarterly pay months. Dealers were expecting this dynamic to play out in September and October of this year as well, but it didn’t happen. Over the past year or two, CLO equityholders have been changing language in the documents to allow equityholders to redeem CLOs on any business day, rather than having to wait for the next quarterly payment date. In late 2017 and early 2018, investors witnessed that the addition of this feature started becoming commonplace, even with top-tier CLO managers. Throughout the year, investors have seen more and more deals taking advantage of this “callable on any business day” feature.
The uncertainty surrounding the timing of CLO redemptions makes it even more important for investors to either develop their own analytical tools or, if outsourcing their CLO investments to another investment manager, to ensure that the investment manager has the necessary tools to analyze these risks. These tools should have the capability of calculating a discount margin to an arbitrary call date. Investors should also be able to discern a given CLO manager’s involvement in redemption activity and the economic incentives to the equityholder associated with different call scenarios. Penn Mutual Asset Management has deep analytical capabilities in these and other areas that help the firm add value to clients’ various total- return strategies in the CLO space.
CLO investors need to understand redemption dynamics and include it in their analysis, as it has a direct effect on the upside/downside of par-callable structures. The old rule of thumb was that CLOs were typically redeemed on any quarterly payment date. However, this tradition has been broken not only in written form through new/updated documentation, but also through behavior as CLO equityholders now take advantage of the increasing flexibility in the timing of redemptions. The prevalence of a new CLO format – the reissue – is another feature that gives CLO equityholders additional flexibility in the timing of redemptions. The complexity associated with analyzing the timing of CLO redemptions highlights the need for sophisticated analytical capabilities when making CLO investments.
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.
This material 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. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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