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 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 $64 billion question: Could regulation squash the CLO revival? Outlook or How I learned to stop worrying and love CLOs 2
Section 1: CLO performance and investor base Brief performance recap Prices and ratings and losses oh my! What do CLO AAA spreads indicate? New investors? What makes CLOs attractive? How has the investor base changed? What are these new investors looking for? 3
2009-03 2009-06 2009-09 2009-12 2010-03 2010-06 2010-09 2010-12 2011-03 2011-06 2011-09 2011-12 2012-03 2012-06 2012-09 Price (% of par) % of AAA CLO notes Performance: CLO prices and ratings recover CLO 1.0 secondary prices recover CLO AAA notes downgraded, but recover 120 AAA AA A BBB BB 100% AAA AA A BBB Below 100 80% 80 60% 60 40% 40 20% 20 0% 0 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Source: Citi Research, Moody s 4
Performance: CLO note impairments have been all but non-existent Cumulative impairment rate from Jan 1996 to May 2012 Realized losses at mat 0.78% Market value EOD 0.02% Unimpaired 98.57% Dist. Exch. 0.17% Other 0.46% Source: Moody s Investors Service 5
Global CDOs ex CLOs US RMBS/HEL Structured Finance US CMBS EMEA ABS, CMBS & RMBS US ABS ex HEL Global CLOs IG Corporates Asia-Pac ABS, CMBS & RMBS Loss rate Performance: CLO losses lower than most other asset classes 50% 45% 40% 35% 30% Five-year cumulative IG loss rates 25% 20% 15% 10% 5% 0% Source: Moody s Investors Service 6
Spread (bps) CLO AAA spreads remain wider than other asset classes warning sign or opportunity? 800 600 AAA secondary spreads CLO AAA Credit Card AAA Auto AAA Student Loan AAA 400 200 0 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Source: Citi 7
Section II: How will CLO volumes change? In the near term CLO issuance has rebounded But making the economics work is challenging In the medium term How big will issuance become? Will CLO issuance match CLO amortization? Where does the CLO market stabilize? What does this mean for CLOs role in the loan market? 8
2004 2005 2006 2007 2008 2009 2010 2011 YTD 2012 Volume ($Bils.) CLO issuance is recovering in 2012 CLO issuance rebounding in 2012. 100 75 50 25 0 Source: Citi 9
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 ($Bils.) AAA spread (bps) CLO issuance climbs in 2012; CLO AAAs fluctuate 8 7 CLO issuance rebounding, AAA spreads moving roughly inversely to volume Issuance Avg AAA spread (excl. MM) 180 170 6 160 5 150 4 140 3 130 2 120 1 110 0 100 Source: Thomson Reuters LPC 10
Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 7/11/12 7/18/12 7/25/12 8/1/12 8/8/12 8/15/12 8/22/12 8/29/12 9/5/12 9/12/12 9/19/12 9/26/12 Inst. loan spreads CLO AAA spreads BBB CLO spreads BB spreads In the short term: The arb is challenging CLO AAA spreads widened as loan spreads narrowed counter-balanced by tightening CLO mezz spreads 1000 900 180 160 660 640 BB DMs BBB DMs 900 800 700 600 500 400 300 200 100 0 B+/B "all in" inst spreads BB/BB- "all in" inst spreads CLO AAA spreads 140 120 100 80 60 40 20 0 620 600 580 560 540 520 500 850 800 750 700 650 Source: Thomson Reuters LPC, LCD, Citi 11
12/31/2011 1/31/2012 2/29/2012 3/31/2012 4/30/2012 5/31/2012 6/30/2012 7/31/2012 8/31/2012 <80 80 to <85 85 to <86 86 to <87 87 to <88 88 to <89 89 to <90 90 to <91 91 to <92 92 to <93 93 to <94 94 to <95 95 to <96 96 to <97 97 to <98 98 to <99 99 to <100 >=100 Bid (% of par) % of loans In the short term: How do secondary loan prices & warehousing (or lack thereof) affect CLO performance? 97 Secondary loan bids rally 30% Loan bids climb in CLOs 96 25% 95 20% 94 93 15% 10% Aug-12 Sep-12 Oct-12 92 5% 91 0% Source: S&P/LSTA Leveraged Loan Index, Thomson Reuters LPC 12
BSL CLO Outstandings ($Bils.) Medium term: Vintage CLOs will disappear rapidly Cumulative decline in CLO reinvestment capacity and CLOs outstanding 300 CLOs Outstanding 250 CLOs in Reinvestment 200 150 100 50 Today 0 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 Source: Citi Research 13
2004 2005 2006 2007 2008 2009 2010 2011 YTD 2012 2013 2014 2015 2016 2017 2018 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 100 90 80 70 Hist. CLO iss. CLO iss needed just to offset Deals exiting reinvestment period 60 50 40 30 20 10 0 *Assumes post-reinvestment capacity of 50% in year 1, 30% in year 2, 20% in year 3 Source: Citi, LSTA 14
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
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% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 1-3Q12 Source: S&P/Capital IQ/LCD 16
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
Spread (bps) Loan spreads are much higher than mid-2000 s Any chance they return to those levels? 900 Primary institutional term loan spreads 800 700 600 500 B+/B inst spreads BB/BB- spreads 400 300 200 100 0 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
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 - 140 bps 50% 50% 40% 40% 30% 30% AA - 250 bps 20% 10% 0% AA -42 bps A - 72 bps BBB - 2.25% BB - 4.15% Equity 2007 20% 10% 0% A - 350 bps BBB - 5.25% BB - 7.25% Equity Today Source: Citi, LSTA 19
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 500 400 CLO WACC BB/BB- TLB spread B+/B TLB spread 300 200 2012 CLO WACC 100 0 2007 2012 20 Source: Citi Research, S&P/LCD, LSTA
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
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
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 250 80% 8% 200 Avg. LIBOR floor % loans with LIBOR floors 70% 60% 7% 6% 05 vintage 06 vintage 07 vintage 150 50% 5% 40% 4% 100 30% 3% 50 20% 2% 10% 1% 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 CLO Vintage 0% 0% 2006 2007 2008 2009 2010 2011 Year of Payment Source: Thomson Reuters LPC, Citi 23
2006 2007 2008 2009 2010 2011 1Q-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
Section IV: CLOs and Regulation Risk retention And FATCA And Volcker Rule OH MY! 25
BSL CLO Outstandings ($Bils.) Regulation and existing CLO lifecycle Outstanding and reinvesting CLO s vs. looming regulation 300 CLOs Outstanding CLOs in Reinvestment 250 200 150 Euro risk retention Basel III begins U.S. Risk Retention: CLOs comply in 2015 FDIC assessments already underway; criteria for new assets change April 13 100 50 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 0 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 Source: Citi Research, LSTA 26
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