INSIGHTS

Calling it

More European CLOs have been called already this year than in any previous full year. This is due to several factors, just one of which is the last legacy deals exiting their reinvestment periods. “The high number

“The high number of calls so far this year is a function of the state of evolution of vintage
CLOs and which part of the lifecycle they are in,” says Chandrajit Chakraborty, principal,
Pearl Diver Capital. “Some of the most prolific CLO issuance was in 2006 and 2007 and
those deals are now generally two to three years out of their reinvestment periods.”

He continues: “That means this is a great time to call these deals, as the loan portfolios
have factored down and the capital stack has been amortised to an extent such that the
effective cost of CLO debt financing increases and the ongoing equity coupons
diminishes to a sub-optimal level.”

Chakraborty notes that the market has generally been expecting calls to pick up this year.
Of the six deals called in 2013, four were issued in 2007 or 2008, while the other two
were from 2005 and 2006. All of the deals called in 2014 were issued in either 2007 or
2008.

Dryden XV and Harbourmaster CLO 11, both called in the first quarter of this year, also
come from the 2007 and 2008 vintages. However, other deals called this year were issued
earlier.
Alzette European CLO and Duchess III CDO are both from 2004. Meanwhile, Cheyne
Credit Opportunity CDO I, Dryden X and Grosvenor Place CLO are all from the 2006
vintage.

Of the seven deals called this year, three ended their reinvestment period in 2012 and one
in 2013, but the others ended in 2011, 2010 and 2007, so it is not simply that deals are
exiting their reinvestment periods and being called. Another strong factor is the recovery
of loan prices, which has made it easier to redeem debt tranches as part of a call.
Bank of America Merrill Lynch European securitisation analysts note that loan
repayment rates have also increased steadily over the last couple of years. This year is
expected to again see a high level of repayments.

“The European loan market has been active for most of the last 12 to 18 months, which
has pushed up prepayments. That, along with average life constraints restricting the
ability of CLOs to buy new loans, leads to loan collateral pools being factored down. It
also means it is increasingly attractive to roll into a new deal, with a fresh reinvestment
period and WAL,” says Chakraborty.

A key attraction of calling deals and issuing fresh CLOs is that deleveraging of legacy
CLOs is typically well underway. As senior debt tranches are repaid and capital
structures become more expensive, equity motivations to call become stronger.
“As an equity investor you are starting to receive diminishing coupons, while the cost of
financing is rising. In those circumstances, a call becomes far more economical,” says
Chakraborty.

He continues: “As CLO issuance picks up, the trade becomes continuing with a vintage
deal and waiting for the market to hit the next cycle. As a first-loss holder, you do not
want to go through a different cycle.”

While this is typically portrayed as something for debt investors to be wary of, there are
also benefits. For example, in many US CLO refinancings, the introduction of more
modern structural elements is often welcome (SCI 29 April).

“There is upside for debt investors where their bonds are trading at a discount. In fact,
debt has traded very well in the secondary market as deals have begun to amortise,” says
Chakraborty.

He concludes: “As calls become more likely, anything trading at a discount shoots up in
demand. However, as a buyer looking to exploit that opportunity, it is becoming
increasingly difficult to source that paper because holders recognise its value.”

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