Repayments rated
CLO debt repayment rates could act as a manager differentiator
Manager differentiation has become ever more important as the Covid-crisis and its resultant CLO market impact continues to play out. Real repayment rates could become the latest tool in the manager selection process as well as an important pricing input.
“Examining how quickly CLO rated debt is being paid down post reinvestment end date on a deal by deal basis provides a readily understood real world statistic,” says Poh-Heng Tan, founder of the CLO Research Group. “The fact that there is a very big disparity between deals underscores how important it is to know the rate as it could have a significant impact on CLO tranche pricing. For example, for the European CLOs with reinvestment end date in the second half of 2018 the annualised CLO debt repayment rate varies between just under 1% and 31%.”
Tan believes such calculations are also a consideration to manager selection. “The repayment rate is a direct function of CLO manager’s behaviour, CLO post-reinvestment end date languages, collateral pool composition, OC breach, WAL test, among others,” Tan says. “As such it enables effective and efficient managers to demonstrate to their investors that discounted CLO debt is a good investment even in a volatile environment like the current one.”
He continues: “A fast repayment rate could potentially provide a lower risk/higher return opportunity to debt investors as older CLO debt was being pulled to par at a faster rate even in this challenging time. Conversely, a slow repayment rate would undoubtedly bode well for CLO equity prices in general. It works well for CLO equity investors when the repayment rate is very low – meaning more optionality and a prolonged stream of healthy equity cashflows.”
Tan suggests around 20% per annum in the first two years would probably be the average expectation from debt investors in a normal functioning credit environment. “The first two years is what matters as later than that the manager and equity investors will be looking at a reset or rolling the deal into a new vehicle instead,” Tan explains.
However, as the below chart shows of the 19 European CLOs with reinvestment end dates in 2018/2019 the majority are falling below such expectations.
Indeed, eight do not make double figures and overall 14 fall below 20%. While only three exceed 25%.
This article was originally published in Structured Credit Investor on 01 October 2020 and has been reproduced with permission.
