CLO Research

CLO equity distributions can sometimes be mistaken for returns. However, it’s crucial to understand that these distributions are not the same as actual returns.

It is encouraging to witness the year-to-date (YTD) upward trend in the floating spreads of collateral for EU CLOs, as observed in a sample of 2021 vintage deals. The inherent long-term, non-recourse funding nature of a CLO structure provides managers with an opportunity to navigate challenging environments and bolster their net interest margins during periods of volatility.

Typically, deals with high OC (BB) test cushions are expected to perform well, though this is not always the case. The median deal with an OC test cushion of 4 to 5 percentage points performed well, achieving 15 basis points (bp) of alpha. Deals with a small OC test cushion experienced more significant underperformance. Among deals with less than 1 percentage point of cushion, approximately three-quarters performed poorer than the loan index.

The table above displays the most recent minimum OC (BB or BBB) test cushions, segmented by vintage year. Interestingly, with the exception of deals from the 2015 vintage, the median deals from each vintage have demonstrated improvement from their levels at inception.

Unsurprisingly, the median 2014 vintage deal has the worst OC test cushion, underscoring the challenges of the 2014 vintage. Excluding 2012 deals due to their low count, the 2013 vintage has the next worst test cushion given that these deals have been outstanding for an extended period. Notably, the median 2018 vintage deal has a concerning test cushion of approximately 1.6 points, indicating a sizable erosion of principal value. This would negatively impact final equity IRRs. It appears that whenever there is a record issuance year, performance is somewhat affected.

Generally, the median values of deals from 2013 to 2022 exhibit healthy OC test cushions. In many cases, the deleveraging of performing deals has been shown to further improve OC ratios, a trend that is evident in the more seasoned deals.

Notably, since late 2020, US CLO managers have, on average, been adding value for their investors. This trend is illustrated by the blue line in the chart, which remains in positive territory. The annualized total return alpha since inception reached its peak around October 2021. This suggests that, on average, US CLO managers tend to add more value during particularly robust market periods. It is important to note, however, that the chart is based on averages. Nevertheless, there are managers who consistently add value in both weak and strong markets.

Generally, it's assumed that larger managers who buy the market might not perform well. However, an analysis of average alpha performance across categories reveals that larger US CLO managers have consistently outperformed their smaller counterparts, as evidenced by a sample of seasoned deals from 2015 to 2019.

Typically, deals that rank well in terms of CCC exposure would be expected to perform well. This appears to be true only to a certain extent. The median deal with CCC exposure of 4 to 5 percent did well, achieving 25 basis points of alpha, while the median deal with CCC exposure of 5 to 6 percent registered an alpha of 22 basis points. However, for deals where CCC exposure ranges between 6 and 11 percent — representing approximately 80 percent of the sample — the relationship between alpha and CCC exposure appears to break down. For instance, deals with CCC exposure in the 9 to 10 percent range tend to perform better than those with CCC exposure between 6 and 9 percent.

Please see the chart below that displays the median DM pricing of primary US MM CLO AAA-BB tranches...

Please see the chart below that displays the median DM pricing of primary US BSL CLO AAA-BB tranches...

Please see the chart below that displays the median DM pricing of primary EU CLO AAA-BB tranches...

Please see the chart below that displays the DM pricing range (45th to 55th percentile) of primary EU CLO BB tranches...

Please see the chart below that displays the DM pricing range (45th to 55th percentile) of primary US BSL CLO BB tranches...

Based on a sample of 315 post-2012 US CLO deals that have been fully redeemed (excluding deals with debt impairment), the median deal displayed a collateral pool factor of 67% prior to full redemption. Notably, among these deals, 75% had a collateral pool factor of at least 41%, while 25% surpassed 98%.