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
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
Trends in the 2017 CLO Market
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. 2017 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 2 10 5 1 - - 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
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) 500 450 AAA AA 1,100 1,000 BBB 400 A 900 BB 350 800 300 250 200 150 100 700 600 500 400 300 50 Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Feb-16 Feb-17 200 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
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 7 6 5 4 3 2 1 0 Reinvestment periods have been trending longer, with a number of 2017 deals having five-year reinvestment periods Source: BAML 6
Relative Value and Returns
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 200 180 180 160 160 140 140 120 120 100 80 60 40 20 CLO AAA Secondary CMBS 10Y AAA Secondary 100 80 60 40 20 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
Spread (bps) Where is the Value in the CLO Capital Structure? 1,000 New Issue U.S. CLO Tranche Spreads 900 800 700 600 500 400 300 200 100 0 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
Performance and Pressure Points: Market Shifts from Credit Concerns to Spread Concerns
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% 102 30% 100 25% 20% 15% 10% Composite LSI Oil & Gas LSI Non Oil & Gas LSI Average LT LSI 98 96 94 5% 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
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
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 120 100 2.0 Liq CLO Equity NAV (floored at zero) 2.0/3.0 Equity Price (1M lag) 80 60 40 20 0 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
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 800 700 600 500 Loan Asset Spread WA CLO Liability Spread 500 450 400 400 350 300 200 100 300 250 0 200 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
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 4.75 0.90 4.50 0.80 4.25 0.70 0.60 4.00 2012 2013 0.50 3.75 2014 0.40 2012 3.50 2015 0.30 0.20 2013 2014 2015 3.25 0.10 3.00 0.00 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
Investment Options: New Issue, Refinancings and Resets
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 25 20 15 10 5 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
AAA Spread (bps) Different Investment Opportunities Exist in New Issue CLOs, Refis and Resets 140 130 120 110 100 90 80 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 - 1.00 2.00 3.00 4.00 5.00 6.00 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
Outlook for CLOs
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? 190 180 170 160 150 140 130 120 60% 50% 40% 30% 20% 10% 110 100 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
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Issuance ($B.) % of survey respondents CLO issuance expected to meet or exceed $70B in 2017 Annual CLO issuance Full year 2017 CLO issuance estimates 140 60% 120 50% 100 80 60 40 20 40% 30% 20% 10% 0 0% <$40 $40 - $50 $50 - $60 $60 - $70 > $70 2017 CLO issuance estimates ($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
Final Views