US CLO Equity: Loan Repricing Risk
With an average of over 40% of loans quoted above par (2014-2020 BSL CLO deals), underlying collateral repricing risk is now presenting another challenge to CLO equity investors, at a time when the actual ‘arbitrage’ is still on the mend.
According to LCD, thus far in January loan the repricing volume has shot to $38.7 billion from 26 transactions. On average, these deals are cutting 69 basis points off the Libor spread, or 84 bps off spread and floor combined.
Refinancing of CLO liabilities should help mitigate the underlying collateral repricing risk. The cost of CLO refinancing (borne by equity investors) needs to be justified by much tighter tranche spreads.
CLO Research believes that CLO liabilities are still too wide and should tighten much more so that CLO Equity actual arbitrage would be more secured. Based on the actual arb data observed so far, the actual US CLO arb picture is not looking good partly due to a tight net collateral margin (portfolio interest return net of WACC incl. management fees).
CLO equity investors need to see a more proportionate risk-return profile, if not, it would have implications on the sustainability of growth in the CLO market.
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