CLOs in 2017 and Beyond

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Austen Allen
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1 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 Stanley Tokyo, June 6, 2017

2 Topics for Today Trends in the 2017 CLO Market Relative Value and Returns Performance and Pressure Points Investment Options: New Issue, Secondary, Refinancings, Resets Outlook for the Remainder of the Year 2

3 Trends in the 2017 CLO Market

4 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Feb-17 Mar-17 Apr-17 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Feb-17 Mar-17 Apr-17 $Bils. Bils U.S. and European CLO Issuance, Refinancings and Resets U.S. CLO Issuance, Refis and Resets Euro CLO Issuance, Refis and Resets 25 4 CLO Resets 20 CLO Resets 3 CLO Refis CLO Issuance 15 CLO Refis CLO Issuance U.S. CLO issuance has been accelerating after a quiet January 2017; however, the market has been dominated by refinancings and resets European issuance is lower; refinancings and resets also gaining traction Source: TR-LPC 4

5 Spread (bps) Spread (bps) U.S. CLO New Issue Spreads Trend Tighter U.S. CLO New Issue Spreads (AA, AA, A Notes) U.S. CLO New Issue Spreads (BBB, BB Notes) AAA AA 1,100 1,000 BBB 400 A 900 BB Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Feb-16 Feb Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 U.S. CLO note spreads have trended tighter In late April, there was a slight uptick in spreads Source: BAML 5

6 03Q1 03Q3 04Q1 04Q3 05Q1 05Q3 06Q1 06Q3 07Q1 07Q3 08Q1 08Q3 09Q1 09Q3 10Q1 10Q3 11Q1 11Q3 12Q1 12Q3 13Q1 13Q3 14Q1 14Q3 15Q1 15Q3 16Q1 16Q3 17Q1 Reinvestment Period (years) U.S. CLO Reinvestment Periods are Trending Longer 8 Average U.S. CLO Reinvestment Periods Trend Longer Reinvestment periods have been trending longer, with a number of 2017 deals having five-year reinvestment periods Source: BAML 6

7 Relative Value and Returns

8 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Feb-17 Mar-17 Apr-17 Spread (bps) Spread (bps) Relative Value: U.S. CLOs vs CMBS; U.S. vs. European CLOs U.S. CLO AAA vs. CMBS 10-Yr AAA Spreads U.S. vs. Euro New Issue CLO AAA Spreads CLO AAA Secondary CMBS 10Y AAA Secondary U.S. CLO AAA Euro CLO AAA 0 - U.S. CLO spreads remain wide relative to CMBS and to European CLO spreads Source: BAML 8

9 Spread (bps) Where is the Value in the CLO Capital Structure? 1,000 New Issue U.S. CLO Tranche Spreads AAA AA A BBB BB B Where is the value in CLO capital structure? Are U.S. or European CLO notes more attractive today? How do U.S. CLO yields stack up relative to other asset classes? Source: BAML 9

10 Performance and Pressure Points: Market Shifts from Credit Concerns to Spread Concerns

11 Jan-06 Sep-06 May-07 Jan-08 Sep-08 May-09 Jan-10 Sep-10 May-11 Jan-12 Sep-12 May-13 Jan-14 Sep-14 May-15 Jan-16 Sep-16 May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 LSI Loan Price (%) Real and Perceived Loan Stress Drops Rapidly Liquidity Stress Index Falls from Early 2016 Highs Loan Prices Rebound from Oversold Levels 35% % % 20% 15% 10% Composite LSI Oil & Gas LSI Non Oil & Gas LSI Average LT LSI % 92 0% 90 Credit and liquidity metrics in the U.S. loan market have improved materially since early 2016 In turn, loan prices have recovered (arguably from very oversold levels) Source: Moody s, BAML 11

12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 MVOC (%) MVOC (%) CLOs Market Value OC Recovers from Early 2016 Dip Market Value OC (CLO AAA and AA Notes) Market Value OC (CLO A, BBB, BB and B Notes) 170% 130% 160% 120% 150% AAA 140% AA 110% 130% 120% 100% A BBB BB B 110% 90% As loan prices improved, so did popular CLO tranche market value metrics Market Value OC (MVOC)* measures whether CLO notes are covered if all assets are sold at their market price As loan prices rebounded, MVOC metrics recovered * Note: this is not a realistic measure as CLOs are not mark-to-market vehicles, and collateral is unlikely to be liquidated Source: BAML 12

13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Mar-17 Equity NAV/Price CLO Equity NAVs and Prices Recover CLO Equity NAV, Prices Recover Liq CLO Equity NAV (floored at zero) 2.0/3.0 Equity Price (1M lag) As loan prices improved, so did popular early-2016 CLO tranche metrics Equity NAV* shows how much value would be left for the equity if all assets were sold and used to repay the CLO notes As loan prices rebounded, equity NAVs recovered * Note: this is an unrealistic measure as CLOs are not mark-to-market vehicles, and collateral is unlikely to be liquidated Source: BAML 13

14 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Apr-17 Jan-12 Apr Jul-12 Oct Jan-13 Apr Jul-13 Oct Jan-14 Apr Jul-14 Oct Jan-15 Apr Jul-15 Oct Jan-16 Apr Jul-16 Oct Apr Spreads (bps) Arbitrage (bps) CLO Asset Spreads Compress Faster than Liabilities Spreads Asset Spreads vs. CLO WA Liability Spreads Asset-Liability Arbitrage Loan Asset Spread WA CLO Liability Spread Unlike early 2016, there is little concern with CLOs collateral performance However, with many loans repricing and refinancing, loan spreads have contracted significantly and faster than spreads on CLO liabilities In turn, the arbitrage has narrowed Source: BAML 14

15 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Spread (%) WAS Cushion (%) Asset Spread Compression Puts Pressure on Weighted Average Spread Tests 5.00 Weighted Average Spreads in CLO Portfolios Compress 1.00 Spreads Compression Puts Pressure on WAS Tests As loan spreads have tightened, weighted average spreads on CLO assets have tightened In turn, CLO WAS cushions are lower than last year Source: BAML 15

16 Investment Options: New Issue, Refinancings and Resets

17 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Feb-17 Mar-17 Apr-17 $Bils. U.S. CLO Market Sees Many Refis, Resets U.S. CLO Issuance, Refis and Resets CLO Resets CLO Refis CLO Issuance - On CLO Refis and Resets: Most 2.0 CLOs allow equity investors to refinance a CLO deal on a tranche-by-tranche basis after the non-call period. New secured notes with lower coupon spreads are generally issued in a refi while the original bonds are redeemed in full using the proceeds from the refi. Equity investors recognize that these deals are now closer than the end of reinvestment and are able to tap debt investors looking for shorter-wal bonds with lower coupon spreads. Refinancings that extend the reinvestment periods are known as resets. Because of the change in deal terms, the consent of all noteholders may be required for a reset to be carried out. As compared to the issuance of a new deal, the up-front cost of doing a reset is likely lower. Equity investors already have some sense of the CLO manager's strategies and if they are pleased with their performance to date, they might be incentivized to carry out a reset. "Rolling over the collateral portfolio" in a reset can also be easier than ramping up a new one from scratch. The SEC issued a no-action letter indicating that deals already in place as of December 2014 will not trigger risk retention requirements if they go through a refi subject to a number of restrictions. Resets do not qualify for this carve-out. Source: TR-LPC, BAML 17

18 AAA Spread (bps) Different Investment Opportunities Exist in New Issue CLOs, Refis and Resets U.S. BSL Credit Curve (AAA Spread vs. Years Until End of Reinvestment) Refi from the primary market Actual Recent Primary BSL CLO Spreads Reset / New- Issue from the primary market Investment Characteristics New Issue CLOs Longer duration Higher spread New portfolio of assets Refinancings Shorter duration Lower spread Familiarity with manager May have some underperforming assets in portfolio Resets Longer duration Higher spread Familiarity with manager May have some underperforming assets in the portfolio Years Until End of Reinvestment Source: BAML 18

19 Outlook for CLOs

20 AAA Discount Margin* bps % of survey respondents Where will U.S. CLO AAA spreads be in the 2H17? AAA Discount Margins Where will U.S. CLO AAA spreads be in 2H17? % 50% 40% 30% 20% 10% Jan-16 Mar-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 0% <100 bps 110 bps 120 bps >130 bps CLO spreads have contracted materially in the past year In a recent survey, over 50% of CLO professionals estimated CLO spreads would be around LIB+110 in 2H17 *Based on a sample of deals where discount margin available Source: TR-LPC 20

21 Issuance ($B.) % of survey respondents CLO issuance expected to meet or exceed $70B in 2017 Annual CLO issuance Full year 2017 CLO issuance estimates % % % 30% 20% 10% 0 0% <$40 $40 - $50 $50 - $60 $60 - $70 > $ CLO issuance estimates ($B.) While slower than in recent years, U.S. CLO issuance has accelerated in recent months In a recent survey, half of CLO professionals expected $70 billion or more of CLO issuance in 2017 Source: Wells Fargo, TR-LPC 21

22 Final Views

The Resurgence of the CLO Market

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 What s new in CLOs and what does it mean for