The option to reset a deal, not available in 1.0 CLOs, involves extending the deal’s reinvestment period, distinguishing it from standard refinancing. Although resetting a deal incurs costs, equity investors (or first-loss retention managers) have concluded that the long-term benefits outweigh these additional expenses.
Resetting a deal is generally more feasible when the deal performs well and market conditions are favorable. Currently, market conditions are conducive. However, except for the ‘obvious’ deals from 2022-2023, which were issued at an opportune time, seasoned deals from the 2014-2021 vintages that rank in the top quartile in terms of Market Value Over Collateralization (MVOC) and Equity Net Asset Value (NAV) are in a better position to utilize this reset option.
The challenge of resetting increases if the deal experiences a significant decline in the market value of its collateral due to poor performance, defaults, and trading losses. Pricing the reset for long-dated liabilities, especially at the mezzanine level, would become prohibitively expensive, even in favorable market conditions. In addition to the higher costs for the reset CLO liabilities, extra capital in the form of unrated debt or equity will be necessary.
Typically, most equity investors would not want to put in new money to go after ‘bad’ money.
Read more in the basic premium article: “US BSL CLOs: A Closer Look at Recent Resets (Updated)“.
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