By the Numbers

Watching the rise of refinancing risk

Caroline Chen | January 5, 2024

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.

By the end of 2024, $829 billion of broadly syndicated loan (BSL) CLOs will have left their non-call period. If the weighted average debt funding cost in the primary market stays around the current level of 230 bp, about 10% of this universe may have good reason to call the debt. And the share may rise to 28% if the weighted average funding cost drops another 25 bp. After limited debt refinancing and deal resets last year, things look about to change.

The estimate of BSL CLO refinancing comes from applying three simple screens:

Deals outside their non-call period by the end of 2024
Deals with a ‘BB’ MVOC greater than or equal to 100%, and
Deals with a weighted average cost of debt funding greater than or equal to 230 bp

Applying those screens to outstanding CLOs suggests 10% of deals eligible for calling debt could consider exercising between now and then and 28% could consider calling if spreads tightened another 25 bp (Exhibit 1). But each screening rule is worth a closer look.

Exhibit 1: Shares of CLOs by issue year that may be called by the end of 2024

Notes: w.a. debt funding costs are calculated based on tranche coupon spreads and tranche balance in INTEX as of Dec 2023. CLOs’ original issue year is based on INTEX classification. Data include BSL CLOs in both amortizing and reinvestment stages with non-call date ending in 2024 or prior years.
Source: INTEX, Santander US Capital Markets LLC

A large number of BSL CLOs may exit non-call periods in 2024

BSL CLOs have a short call protection period, typically two years after deal closing. Today, most BSL CLOs are outside the non-call periods. By the end of 2024, an additional $127 billion CLOs will reach the end of their call protection (Exhibit 2).

Exhibit 2: Most BSL CLOs are out of their call protection periods

Notes: Numbers represent outstanding CLO deal balances as of December 2023. BSL CLOs issued in 2023 only include deals currently modeled in INTEX. CLOs’ original issue year is based on INTEX classification.
Data source: INTEX, Santander US Capital Markets LLC

New issue pricing has improved, leading to increased activity in refinance and reset market

While the $22 billion BSL CLO refinance and reset volume in 2023 was a low print compared to past years, the market was active through the second half of the year when the median of ‘AAA’ new CLO pricing spread dropped to below 190 bp (Exhibit 3). In December, CIFC priced a ‘AAA’ tranche at 160 bp, a new tight for 2023. The weighted average new BSL CLO debt funding cost was around 230 bp by the end of 2023.

Exhibit 3: Managers’ refinance and reset activity has picked up recently

Notes: new ‘AAA’ spread and w.a. debt funding cost are the median of all BSL CLOs priced in a month.
Source: LCD PitchBook, Santander US Capital Markets LLC

The market value of loan assets in most CLOs exceeds the par value of debt

This is the most complex screening rule. The market value of the CLO loan portfolio will influence the ability of a CLO to realize the tightest primary market spreads. Portfolio market value may have a minor influence in refinancing the ‘AAA’ and other highly rated classes but a major influence in refinancing the ‘BB’ and other lower rated classes. In the extreme, managers cannot afford to call a CLO if the market value of its loan assets is less than the par value of its debt. The market value overcollateralization (MVOC) ratio captures that for each class of debt. The higher the MVOC, the tighter the spread.

The robust performance of leveraged loans through 2023 increased the market value of loan assets in most CLOs. While loan prices will continue to fluctuate in 2024, 90% of BSL CLOs that were out of the call protection period by the end of 2023 already had higher aggregate asset value than debt, as implied by the MVOC of ‘BB’ tranches (Exhibit 4). Having a ‘BB’ MVOC of 100% probably means a manager would pay a very wide spread to refinance that class—likely much wider than a new ‘BB’—making refinancing of the ’BB’ unlikely. However, the same deal could have a ‘AAA’ MVOC only slightly lower than a new ‘AAA’, giving the manager a better chance at realizing tight spreads. The bigger message is that regardless of the MVOC of the ‘BB’, a lot of CLOs will likely consider at least partial refinancing of investment grade debt.

Exhibit 4: Most CLOs outside the non-call period have asset market value higher than debt

Notes: Data reflect outstanding BSL CLOs with non-call date ending in 2023 or earlier. Loan asset market prices were from IDC/ICE in INTEX as of December 21, 2023. CLOs’ original issue year is based on INTEX classification.
Data source: INTEX, Santander US Capital Markets LLC.

Funding costs for amortizing CLOs rise over the time, and more CLOs may amortize in 2024

About 35% of outstanding BSL CLOs were in their repayment period by the end of 2023, but the share may increase to 46% by the end of 2024 based on the current deal balances. Even coupon spreads of an amortizing CLO debt are tighter than the current pricing spreads of comparably rated debt tranches in the primary market, managers may still call an amortizing CLO for refinance or reset. This is because the paydown of ‘AAA’ tranche, the cheapest CLO debt, over the time increases managers’ weighted average debt funding cost. The reset of Generate CLO 3 in December is a good example (Exhibit 5).

Exhibit 5-1: Generate 3 reset CLO priced all debt spreads wider

Exhibit 5-2: The same CLO debt funding cost may increase by16 bp in January without reset

Notes: Under the assumption of 20% CPR, 2 CDR and 70% recovery, a $54 million paydown of ‘AAA’ will occur in January 2024.
Source: Bloomberg, INTEX, Santander US Capital Markets LLC

It is worth noting that repayment speeds in amortizing CLOs vary greatly by manager. It is possible that some fast-repaying CLOs may see debt funding cost rise quickly, as the example of Generate CLO 3 shows. CLOs with original issue years in 2018 or earlier are primarily amortizing today. As their ‘AAA’ debt continue to pay down, the share of CLOs in older vintages that looks appealing to call may be even higher than exhibit 1 show.

Caroline Chen
caroline.chen@santander.us
1 (646) 776-7809

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