Seasoned CLO deals that make minimal or no equity distributions are under considerable pressure to be redeemed, with some investors eager to take advantage of any opportunities that arise. One example is a 2014 vintage deal that was recently redeemed. This deal experienced high annualized prepayment rates of around 31% in the first two years post reinvestment period. As a result, the cost of funding surpassed the portfolio’s weighted average spread (WAS) since late 2021, leading to the deferment of interest payments on its single-B tranche. In fact, the equity tranche of this deal did not receive any interest distributions since July 2021.
Another important consideration for this deal is its legal maturity date, which falls in July 2025. However, it is worth noting that CLO deals rarely reach maturity, leading to higher annual collateral par loss rates due to mark-to-market (MTM) losses. This, in turn, results in implied default rates that exceed reported defaults, factoring in trading losses and defaults. For the 2014 vintage deal, the reported annual default rate was 0.7% based on the original collateral balance, while the implied annual default rate was 2.0%, assuming a recovery rate of 65%. Due to a combination of these factors, the equity tranche of this deal suffered from a negative internal rate of return (IRR).
When examining the five most recently redeemed seasoned US CLO deals, their annual collateral par loss rates ranged from 0.48% to 0.78%. This indicates annual default rates of 1.4% to 2.2%, based on the original collateral balance, assuming a recovery rate of 65%.
Related article:
Evaluating the Performance of 5 Recently Redeemed US CLO Equity Tranches (Premium)
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