The recent rally in loan prices has prompted equity investors to start exercising calls on CLOs, with potentially more on the way if the current upswing continues.
So far, two CLO 2.0s have been called this year, both in April. This follows 13 2.0 optional redemptions in 2015 and six in 2014 In total, 10 CLOs have been called this year, following 89 in 2015, 85 in 2014, and 75 in 2013, according to J.P. Morgan.
This year’s called 2.0 transactions are the Mill Creek CLO from 40/86 Advisors and Babson 2011-I, both of which were originally issued in 2011.
When looking at the factors that increase the likelihood of a call, analysts at Nomura determined that higher equity net asset values (NAVs), higher costs of funding, and lower cash flows to the equity increase the likelihood that a CLO gets called. Analysts at J.P. Morgan also cited the equity purchase price, loan sourcing conditions, and the type of investor holding the equity are additional factors.
The Mill Creek CLO, which is 15 months past its reinvestment period, saw average quarterly payments to its equity over the past few years of under 3%, well below the average CLO 2.0. Its most recent equity NAV was about 48% though, which is in the 82nd percentile across all 2.0s, according to data from Nomura analysts.
The Babson 2011-I, which is 19 months past its reinvestment period, similarly saw its average quarterly distributions to the equity fall to 2.9%, from 5%, while its NAV was around 44%, which is within the top quarter of CLO 2.0s.
Looking ahead, Nomura analysts see another nine CLO 2.0s past their reinvestment periods that are candidates for an optional call since their quarterly equity distributions have fallen by 1.2% or more and their equity NAVs are above 36%.
Analysts at J.P. Morgan believe that a sustained rally in loan prices could lead to more CLO 2.0s getting called since the call also provides an exit for some of the equity that has exchanged hands over the past few months.
The entire CLO 1.0 universe is otherwise past its non-call and reinvestment periods at this point. The 2006 vintages were over half of the total CLO 1.0s called last year followed by the 2007 vintage. Over the next few years, J.P. Morgan analysts anticipate that the 2007 vintage will take over as the most actively called. Typically CLO 1.0s that were called in 2015 had 32% of the original transaction size outstanding and were about three years past the end of their reinvestment periods.
The same goes for Europe
In Europe too, some expect improved secondary loan market prices to trigger more CLO redemptions. In its April 8 European Asset-Backed Barometer, Deutsche Bank Markets Research suggested several other deals issued in late 2005/2006 that may become economical to call, including Wood Street II (Alcentra), Green Park 2006-1 (Blackstone), Boyne Valley CLO (via AIB Capital Markets), and Theseus 2006-1 (Invesco).
There has been a marked increase in loan BWIC activity in both the U.S. and European secondary loan markets in recent weeks, some of which may related to CLO redemptions, sources said. Through April 8, 14 European BWICs totaling €744 million have been put up for sale, versus €1.2 billion from nine BWICs in the same period last year, according to LCD data. That’s a 56% increase in deal count over last year, although the volume figure trails by 40%. Meanwhile, in the U.S., there has been a flurry of BWIC and OWIC activity as well, with the amount of loans put up for sale via BWICs through April 8 standing at $5.5 billion, up from $1.6 billion in the year-ago period. CLO 1.0 redemptions have driven these portfolio sales.
Three European CLOs have been called so far in 2016, including BNPP IP’s Leveraged Finance Europe Capital IV, Versailles CLO M.E.I, and Dalradian European CLO IV. In 2015, LCD tracked 28 call notices, with 26 issued by CLO 1.0 transactions and two by CLO 2.0s. The most recent European CLO BWIC was for a pending CLO redemption from a large, established manager. — Andrew Park/Sarah Husband