The Resurgence of the CLO Market

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Sylvia Gardner
6 years ago
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1 The Resurgence of the CLO Market Meredith Coffey, LSTA Moderator John Clements Citigroup David Golub Golub Capital Bret Leas Apollo Rob Zable GSO/Blackstone 1

2 What s new in CLOs and what does it mean for loans? CLO s stunning performance to date do investors care? What does CLO issuance look like in the near term? The medium term? How will changes in CLOs change the loan market? The $64 billion question: Could regulation squash the CLO revival? Outlook or How I learned to stop worrying and love CLOs 2

3 Section 1: CLO performance and investor base Brief performance recap Prices and ratings and losses oh my! What do CLO AAA spreads indicate? New investors? What makes CLOs attractive? How has the investor base changed? What are these new investors looking for? 3

4 Price (% of par) % of AAA CLO notes Performance: CLO prices and ratings recover CLO 1.0 secondary prices recover CLO AAA notes downgraded, but recover 120 AAA AA A BBB BB 100% AAA AA A BBB Below % 80 60% 60 40% 40 20% 20 0% 0 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: Citi Research, Moody s 4

5 Performance: CLO note impairments have been all but non-existent Cumulative impairment rate from Jan 1996 to May 2012 Realized losses at mat 0.78% Market value EOD 0.02% Unimpaired 98.57% Dist. Exch. 0.17% Other 0.46% Source: Moody s Investors Service 5

6 Global CDOs ex CLOs US RMBS/HEL Structured Finance US CMBS EMEA ABS, CMBS & RMBS US ABS ex HEL Global CLOs IG Corporates Asia-Pac ABS, CMBS & RMBS Loss rate Performance: CLO losses lower than most other asset classes 50% 45% 40% 35% 30% Five-year cumulative IG loss rates 25% 20% 15% 10% 5% 0% Source: Moody s Investors Service 6

7 Spread (bps) CLO AAA spreads remain wider than other asset classes warning sign or opportunity? AAA secondary spreads CLO AAA Credit Card AAA Auto AAA Student Loan AAA Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Source: Citi 7

8 Section II: How will CLO volumes change? In the near term CLO issuance has rebounded But making the economics work is challenging In the medium term How big will issuance become? Will CLO issuance match CLO amortization? Where does the CLO market stabilize? What does this mean for CLOs role in the loan market? 8

9 YTD 2012 Volume ($Bils.) CLO issuance is recovering in 2012 CLO issuance rebounding in Source: Citi 9

10 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Volume ($Bils.) AAA spread (bps) CLO issuance climbs in 2012; CLO AAAs fluctuate 8 7 CLO issuance rebounding, AAA spreads moving roughly inversely to volume Issuance Avg AAA spread (excl. MM) Source: Thomson Reuters LPC 10

11 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 7/11/12 7/18/12 7/25/12 8/1/12 8/8/12 8/15/12 8/22/12 8/29/12 9/5/12 9/12/12 9/19/12 9/26/12 Inst. loan spreads CLO AAA spreads BBB CLO spreads BB spreads In the short term: The arb is challenging CLO AAA spreads widened as loan spreads narrowed counter-balanced by tightening CLO mezz spreads BB DMs BBB DMs B+/B "all in" inst spreads BB/BB- "all in" inst spreads CLO AAA spreads Source: Thomson Reuters LPC, LCD, Citi 11

12 12/31/2011 1/31/2012 2/29/2012 3/31/2012 4/30/2012 5/31/2012 6/30/2012 7/31/2012 8/31/2012 <80 80 to <85 85 to <86 86 to <87 87 to <88 88 to <89 89 to <90 90 to <91 91 to <92 92 to <93 93 to <94 94 to <95 95 to <96 96 to <97 97 to <98 98 to <99 99 to <100 >=100 Bid (% of par) % of loans In the short term: How do secondary loan prices & warehousing (or lack thereof) affect CLO performance? 97 Secondary loan bids rally 30% Loan bids climb in CLOs 96 25% 95 20% % 10% Aug-12 Sep-12 Oct % 91 0% Source: S&P/LSTA Leveraged Loan Index, Thomson Reuters LPC 12

13 BSL CLO Outstandings ($Bils.) Medium term: Vintage CLOs will disappear rapidly Cumulative decline in CLO reinvestment capacity and CLOs outstanding 300 CLOs Outstanding 250 CLOs in Reinvestment Today Source: Citi Research 13

14 YTD Volume ($Bils.) CLO issuance has to top YTD 2012 levels just to offset CLOs going out of reinvestment CLO issuance: Historical vs. amount needed to replace CLOs going static Hist. CLO iss. CLO iss needed just to offset Deals exiting reinvestment period *Assumes post-reinvestment capacity of 50% in year 1, 30% in year 2, 20% in year 3 Source: Citi, LSTA 14

15 Section III: How a changing CLO market could lead to a changing loan market Why CLOs are especially important to the loan asset class The interplay between vintage and new CLOs How changing CLO cost of funding will impact loan spreads Will LIBOR floors stick? Will CLO baskets ultimately constrain covenant lite loan issuance...or will baskets constrain CLO performance? Are Amends & Extends a one-cycle event? 15

16 Share (%) CLOs remain the biggest single institutional investor, Bringing stability to loans for now? Investor market share in primary 80% 70% 60% 50% Fin Co Ins Co 40% Hedge, Dist, HY Fund Loan Mutual Fund 30% CLO 20% 10% 0% Q12 Source: S&P/Capital IQ/LCD 16

17 Loan wish lists: Vintage CLOs vs. new CLOs Vintage CLO wish list New CLO wish list Needs shorter-maturity loans due to WAL test Call protection Can tolerate lower spreads due to lower WACC Limited covenant lite constraints Can do long-maturity loans Needs higher spreads due to higher WACC Covenant lite constraints Limited Amend & Extend constraints Amend & Extend constraints And more. And more 17

18 Spread (bps) Loan spreads are much higher than mid-2000 s Any chance they return to those levels? 900 Primary institutional term loan spreads B+/B inst spreads BB/BB- spreads Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Source: S&P/Capital IQ/LCD 18

19 CLO cap structure CLO cap structure CLO Weighted Average Cost of Capital (WACC) has climbed markedly 100% 2007 s CLO WACC: 44.5 bps Today s CLO WACC: 195 bps 100% 90% 90% 80% 80% 70% 60% AAA - 23 bps 70% 60% AAA bps 50% 50% 40% 40% 30% 30% AA bps 20% 10% 0% AA -42 bps A - 72 bps BBB % BB % Equity % 10% 0% A bps BBB % BB % Equity Today Source: Citi, LSTA 19

20 Spread/WACC (bps) Higher CLO WACC in 2012 won t support 2007 level loan spreads 600 CLO WACC vs. BB/BB- and B+/B TLB spreads CLO WACC BB/BB- TLB spread B+/B TLB spread CLO WACC Source: Citi Research, S&P/LCD, LSTA

21 7/1/09 9/1/09 11/1/09 1/1/10 3/1/10 5/1/10 7/1/10 9/1/10 11/1/10 1/1/11 3/1/11 5/1/11 7/1/11 9/1/11 11/1/11 1/1/12 3/1/12 5/1/12 7/1/12 9/1/12 YTM (%) Cross over investors also likely to leave when loan spreads get too narrow 4.0% Loan-bond yield differential has fallen sharply 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% Source: S&P/Capital IQ/LCD, LSTA 21

22 Share o new issue loans Relative value investors only interested in loans at certain yield points will leave if spreads drop too low Hedge funds/hy/rv accounts play small role in higher rated (lower yielding) loans 100% 90% 80% 70% 60% 50% 40% Loan Fund Ins Co Fin Co Hedge/HY/RV CLO 30% 20% 10% 0% <= B-/B2 or B/B3 or unrated >= B/B2 22 Source: S&P/LCD

23 Floor (bps) % of loans with floors Qtrly distribution (%) LIBOR floors have supported CLO equity performance will they stick? LIBOR floors are widespread Supporting strong quarterly distributions in CLOs % 8% 200 Avg. LIBOR floor % loans with LIBOR floors 70% 60% 7% 6% 05 vintage 06 vintage 07 vintage % 5% 40% 4% % 3% 50 20% 2% 10% 1% CLO Vintage 0% 0% Year of Payment Source: Thomson Reuters LPC, Citi 23

24 Q-3Q11 1Q-3Q12 Issuance ($Bils.) Market share (%) Covenant lite loans return but will new CLO constraints limit the cov-lite market? 120 Covenant lite issuance and market share 35% 100 Cov lite iss Cov lite market share 30% 80 25% 20% 60 15% 40 10% 20 5% 0 0% 24 Source: S&P/LCD

25 Section IV: CLOs and Regulation Risk retention And FATCA And Volcker Rule OH MY! 25

26 BSL CLO Outstandings ($Bils.) Regulation and existing CLO lifecycle Outstanding and reinvesting CLO s vs. looming regulation 300 CLOs Outstanding CLOs in Reinvestment Euro risk retention Basel III begins U.S. Risk Retention: CLOs comply in 2015 FDIC assessments already underway; criteria for new assets change April Today CLOs (probably) must register/seek commodity pool exemption Volcker goes into effect FATCA principal/sales withholding begins FATCA reporting & interest withholding begins FATCA grandfathering ends Source: Citi Research, LSTA 26

27 Key takeaways CLO performance was remarkably strong in the Great Recession CLO investors realize this and are returning But not in the same numbers which means CLO outstandings may well contract In addition, the CLO investor base has changed, has different return needs Which leads to a higher WACC Which means loan spreads cannot contract like mid-2000s And new CLO constraints may lead to a different looking loan market 27

CLOs in 2017 and Beyond

CLOs in 2017 and Beyond Moderator: Meredith Coffey, LSTA Panelists: Wynne Comer, Bank of America Merrill Lynch Obinna Eke, BNP Paribas Andrew Gordon, Octagon Natsuki Kajima, MUFG Loris Nazarian, Morgan