By the Numbers
Looking at the CLO 20% CPR assumption
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
The average loan repayment rate in the S&P/LSTA leveraged loan index has moved around over time, although the market has long adopted the simplifying assumption of 20 CPR. But loan repayment rates have tumbled this year and in other episodes of Fed tightening and wider loan spreads. CLOs leaving their reinvestment period over the next few years—especially ones trading at deep discounts—look the most vulnerable to slowing speeds. And portfolio maturity profiles look likely to become more important.
The average repayment rate in leveraged loans has run particularly low this year with no monthly annualized rate surpassing 20% in the first six months and the latest monthly print, in June, a mere 10% (Exhibit 1). It seems fair to chalk that up to a combination of actual Fed tightening, anticipated Fed tightening and wider loans spreads, among other things—although spreads could just reflect the expected impact of tightening and slower growth. Wider loan spreads take away the opportunity for borrowers to repay and lower their cost of funds. This is not the first time the market has seen this. The 3-month rolling average annualized repayment rate in the S&P/LSTA index fell from 35% in December 2016, for example, to 16% at the end of 2018 while the Fed funds target rate inched from 0.5% to 2.5% and spreads widened. Repayment rates also generally fell as the Fed tightened from 2004 into 2006.
Exhibit 1: Leveraged loan repayment rates have slowed through Fed hiking
Note: the shaded area represents the Fed rate hike period. Monthly repayment rate = sum of all repayments in the month divided by the outstanding loans in the index. Annualized monthly rate = 1- (1- month repayment rate)^12.
Source: S&P LCD, Bloomberg, Amherst Pierpont Securities
CLO investors need to reconsider the standard 20 CPR repayment assumption with the Fed hiking aggressively and with heightened risk of a recession, especially for CLOs with reinvestment periods ending in a year or two. CLOs exiting or out of their reinvestment period are vulnerable to slower repayments and extending weighted average lives. And investors in these CLOs trading at discounts to par dollar prices could see significant differences in returns.
Managers’ challenges after reinvestment
A total of 887 CLOs with $430 billion in collateral balance have reinvestment periods that end by December 2024. Those CLOs will be most exposed to the slowdown in loan repayments. Managers also face some limits on trading after the end of reinvestment, especially in weaker credits. Concentration of distressed credit could add to extension risk, especially if the economy ends up in recession.
The 25 CLO managers with the largest absolute exposure to deals that exit reinvestment by December 2024 manage 55% of the market’s total exposure (Exhibit 3). Those largest 25 have only 2.78% exposure to loans now trading at $80 or below, although the range across these managers runs from 1.46% to 5.45%. The relatively low concentrations of distressed credits suggest it is not yet an issue for senior classes, which are first in line to get repaid from loan proceeds, but could be an issue for junior classes.
Exhibit 3: Managers with the largest balances leaving reinvestment by Dec 2024
Note: The data includes CLOs with reinvestment periods end in 2024 or prior and current collateral balance over $100 million. Data as of June 2022.
Source: Intex, Amherst Pierpont Securities.
Not every CLO looks likely make the 20% CPR assumption over the next few years if slowing growth or outright recession keeps loan spreads wide. This puts a bigger burden on the maturity profile of a manager’s portfolio and the ability of the borrower to repay at maturity, and current price may signal the market’s view of that ability. Keep an eye on loan maturity profile and on the concentration of distressed debt. Weighted average life and returns to CLO debt look likely to depend on it.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
