CLO Research

Investing in discounted BB-rated CLO tranches can yield significant rewards in the following scenarios:

Debt investors generally prefer a quicker prepayment rate, as this results in a faster pull to par. Conversely, a slower prepayment rate would lead to a longer duration of the debt tranches and potentially higher price volatility if the MVOC is also low. On the other hand, CLO equity investors would prefer to see low prepayment rates, especially during the first two years following the reinvestment period.

The WACC for the most recent US BSL CLO reset deal was priced at approximately 228 basis points (bp). The table below lists a total of 96 deals from 2022 with a WACC exceeding 240 bp. These deals offer a potential cost savings of at least 12 bp. This figure aligns with the cost savings of 12 bp, which corresponds to the 25th percentile, observed in the reset pricing of 2019 vintage deals.

The WACC for the most recent EU CLO deal, which included a single-B tranche, was priced at approximately 285 basis points (bp). The table below outlines a total of 20 deals from 2022 that feature a WACC exceeding 294 bp. These deals present a potential cost savings of at least 9 bp. This figure aligns with the cost savings of 9 bp, which corresponds to the 25th percentile, observed in the reset pricing of 2019 vintage deals.

Despite the EU's lower interest rate environment, we have observed that EU CLO equity tranches in reset deals have exhibited higher median annual distributions than their US counterparts across vintages from 2013 to 2015 and 2017 to 2018.

US CLOs generally enjoy a competitive edge over their EU counterparts in the realm of equity distributions, primarily due to a more favorable interest rate environment in the U.S. Nevertheless, despite the disadvantage posed by the EU's lower interest rate environment, CLO deals from 2017 and 2018 in the EU display notably better NIM and first distribution metrics. These strong figures effectively offset this drawback, as highlighted by their robust annual distributions.

The due diligence list could be endless. The objective of dedicating many hours to due diligence is to select a manager who not only performs well but also does so consistently. A proven track record of delivering strong investment performance—not merely presenting compelling deal metrics—is key.

Non-reset seasoned deals from 2012 to 2016 exhibited considerably poorer performance compared to their reset counterparts.

Below are tables presenting the MVOC (AAA-B) and EQ NAV of EU CLO deals by vintage, based on asset prices...

Below are tables presenting the MVOC (AAA-B) and EQ NAV of US BSL CLO deals by vintage, based on asset...

For the older vintage deals, the median annual distributions were largely in the 13-15% range. However, the median 2014 and 2015 vintage deals stood out with impressive 14.5-14.9% annual distributions. If the 2014 median equity tranche can be sold at a price of EUR 34, then the primary equity investor would achieve the target 12.0% IRR over an 8.7-year period, assuming an issue price of EUR 95.

The table below shows the latest number of post-2012 US CLO deals that have failed at least one of the key tests – interest diversion, overcollateralization, or interest coverage tests – broken down by vintage.

In essence, resetting a deal extends the total reinvestment period, which is positive from an equity standpoint. If a CLO deal can generate an annual equity distribution of 13–14 points over a period of 8–11 years, its equity is likely to perform reasonably well, even if its final equity NAV is poor. It’s worth noting that most of the seasoned reset deals were active during a period of very low-interest rates.

In the table below, the relative standing of each US CLO manager is illustrated based on their latest average total alpha metrics. A score of 91% means that the manager's total return alpha is at the 91st percentile, indicating that their total return alpha metric is higher than 91% of their peers.

Given the similarity in average annual sale volumes between these two sets of managers, it becomes apparent that the volume of trading has limited influence on the alpha performance of managers, as per the findings of this study. It is worth noting that both active and less active managers, in terms of trading activities, are well represented in both the upper and lower segments of manager performance.