With the current attractive yield offered by new issue US CLO BB tranches, it comes as no surprise that this risk-return profile is generating significant interest. The table below illustrates the projected annual yield of a recently priced US BSL CLO BB tranche.
Upon redemption, a CLO BB tranche will pay par principal value. However, it is worth noting that CLOs rarely mature on their designated maturity dates. Conversely, the equity tranche typically yields a much lower final equity NAV compared to par. Nevertheless, it is worth mentioning that most of the redeemed CLO equity deals issued in 2020 saw a solid final equity NAV with above-par value – though those trades were primarily driven by principals rather than long-term regular arbitrage trades. As for the outstanding 2020 vintage deals, many of them had undergone resets, effectively transforming them into regular arbitrage deals.
Considering a 20CPR (Constant Prepayment Rate) and an asset reinvestment assumption of a 72-month bullet maturity, the recently priced BB tranche could potentially yield close to 13.0% to maturity. Consequently, equity investors certainly want a much higher projected IRR target. Could this be the main reason for the so-called lack of arbitrage opportunities?
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