4.19.2010

Back from the Dead: The CLO Revival

Last week it was reported that Symphony Asset Management is launching a $500M CLO. To give you some historical context of CLO issuance, please see the chart below from an 2009 LSTA conference:


This would be the second CLO launch of the year. Combined with the $525M CLO placed by Fraser Sullivan earlier in the year, and this $500M Symphony deal, CLO issuance will reach the $1 billion dollar mark, with more deals expected in the second half of the year. Compared to the chart above, that $1 billion dollars looks awfully minuscule.

According to various news reports, this CLO will purchase new deals, and given the current state of the primary market, will have a substantial amount of supply to choose from. The AAA tranche will be $317M in size, $113M to a Class B tranche (rated Ba2 from Moody's) and $70M in equity notes. In addition, it is reported that the AAA tranche will be held by one investor.

Given the $70M of equity versus the $430M of debt, this deal will be slightly more than 6.1x levered versus 2006 and 2007 structures which were 12-13x levered. While I have not heard hard data on the potential for equity returns in the structure, it is rumored that they will somewhere in the low-mid teens which is slightly less from what equity investors were told they would earn in the go-go years (2004-2007).

From looking at my runs, the Fraser Sullivan deal priced their AAA tranche at L + 190. Here is a chart of AAA and AA CLO liability spreads (again from LSTA)

If you were to show the most recent data, these levels would be even tighter. While investors have varying preferences for investing in legacy CLO liabilities or new CLO liabilities, it is readily apparent that the market is in far better shape than it was at this time last year.

Assuming investors can place the subordinated tranches of these structures, it seems likely that we will see more of these structures announced throughout the year. There has been substantial consolidation in CLO manager land which further bolsters the case that CLO liability investors will become comfortable with the less levered, more modest 2010 CLO vintages. And given that AAA liabilities are pricing near L+200 vs L+40 in 2007, investors are surely being paid a premium to play in these structures.

What this means for buy-side investors? More competition in the primary leveraged loan market where most deals today are already well oversubscribed. Also - more capital available for refinancing troubled borrowers or busted LBOs. The last thing this market needs is more capital - unfortunately, I think that is exactly what we are about to get.

4 comments:

Morally Bankrupt 4/20/2010  

Hi Hunter,

Really enjoy your blog. Not a real pro when it comes to credit, but I try to keep up. I was hoping you could explain some things like what "L +200" means (Loan yield + 200bp?) and explain in more detail what you mean by CLO leverage. Do you mean that the CLO has embedded leverage? I take it it isn't via margin by the 6x figure. Is it through preferred shares?

any information you could post about the workings of CLO internals would be much appreciated by me, and I suspect a good deal of your readership. This stuff isn't widely covered.

David Merkel 4/20/2010  

We never learn. After a bout of too much leverage, we begin cranking it up again. Make money in the short-run, and devil take the hindmost.

Anonymous,  4/21/2010  

I think the L is LIBOR, and the leverage figure just means that there's 6x more debt securities issued by the CLO (investors get contractual interest and principal) vs. the equity piece, that gets the scraps.

David in London,  6/23/2010  

Hi Hunter, do we know what will happen to CLO spreads when interest rates begin to rise ?

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hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.