By the Numbers
Opportunity in fast post-reinvestment CLOs
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.
About 215 broadly syndicated loan (BSL) CLOs will leave their reinvestment period in the second half of this year, with total post-reinvestment CLOs reaching 35% to 40% of all outstanding BSL CLOs by the end of 2023. As many CLO bonds begin to amortize, repayment rates look likely to have a material impact on returns. Investors should find good opportunity in ‘AAA’ classes trading below par with fast repayment rates while avoiding the slow crowd.
Of post-reinvestment CLOs, 75% have repaid below 20% CPR
CLOs entering the post-reinvestment period often pay down debt with repayments from underlying loans or proceeds from loan sales. However, depending on CLO documents governing managers’ trading activity, managers may continue to trade during the post-reinvestment period, primarily for maintaining or improving the loan portfolio quality. From the combination of loan maturities, refinancings and manager trading provisions, the repayment rates in post-reinvestment CLOs can vary greatly. Of the 322 CLOs currently in the post-reinvestment period, a quarter have amortized at an annualized rate of 4% or less and a cumulative 75% slower than the 20% CPR norm used in CLO pricing and valuation (Exhibit 1). That leaves roughly 25% of post-reinvestment deals paying fast.
Exhibit 1: Slow amortization is discernible in many post-reinvestment CLOs
Notes: The data includes 322 BSL CLOs with a reinvestment period ending on Feb 20, 2023, or prior. Intex updates as of 2Q, 2023, with the deals’ last payment date either in April or May. The average repayment rate of a CLO is the average of every quarter’s annualized repayment rate since the end of the reinvestment period.
Source: INTEX, Santander U.S. Capital Markets LLC.
Repayment rates have different impact on bonds across the capital stack
Bonds at the top of the CLO capital stack, which are first in line for getting principal back after the reinvestment period ends, are most sensitive to changes in repayment rates. As a result, swings in repayment rate can have a meaningful impact on effective discount margin. Take CGMS 2016-4A, a post-reinvestment CLO managed by Carlyle, as an example. A swing in repayment rate from 4 CPR to 20 CPR can shorten the WAL of the ‘AAA’ Class A1R from 1.88 years to 1.11 years. And the discount margin can go from 148 bp to 157 bp. By contrast, the WAL and yield of bonds at the lower part of the capital stack in the same deal are less sensitive to changes in repayment rates (Exhibit 2). For other deals with debt trading at lower prices or with faster repayment rates, the impact on the ‘AAA’ class can be even greater.
Exhibit 2: A sample CLO bond valuation under different repayment assumptions
Notes: In addition to the repayment rates, other assumption inputs for bond valuation include 2 CDR, 70% recovery, a 6-month recovery lag, and 50% recovery for defaulted loans. Bond coupon benchmark rates are TSFR3m plus 26 bp credit spread adjustments. GSMS 2016-4A has its reinvestment period ending in July 2021. The average post-reinvestment period repayment rate has been around 16% since the end of the reinvestment period. Indicative bond prices are based on the overall trading color in the secondary market and are not the actual bond price.
Source: INTEX, Santander US Capital Markets LLC.
The 20% CPR norm used in CLO pricing and valuation may only be true for a small number of CLOs in the post-reinvestment period. Investors need to monitor managers’ trading activity closely. Some CLO documents may provide managers limited trading discretion after the end of the reinvestment period, and ‘AAA’ bonds in those CLOs may be good candidates for short-duration portfolios. Attention to repayment in speed in CLOs promises to be a valuable source of excess return for CLO portfolios as long as much of the market continues to trade below par after the reinvestment period ends.
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