Burst of CLO refinancing expected before the end of Libor
(Bloomberg) – Managers of secured loan bonds in the United States may look to block more refinances and related transactions by the end of this year, before the CLO and loan markets start to shift to different references and become potentially chaotic.
A lack of consensus on whether to replace the London Interbank Offered Rate could cause turmoil for CLOs in the fourth quarter, according to Bank of America Corp. The benchmark is widely used across the industry and is expected to be phased out by June 2023 at the latest.
This could add even more steam to the boom in refinancing and “resets” of CLOs, which allow portfolio managers to lock in better terms on open trades. Total combined sales this year are set to surpass $ 100 billion, according to data compiled by Bloomberg, the fastest pace on record as the tally hits a likely annual high.
The Libor transition is not new, but regulators have said US banks should end Libor origination “as soon as possible” and no later than December 31 of this year. Libor will retire definitively in June 2023.
The lack of clarity regarding a replacement, as well as potential mismatches between the benchmarks used for CLOs and the underlying leveraged loans, could result in a widening of CLO premiums later this year. CLOs already suffer basis risk with leveraged loans – most leveraged loans are pegged to one-month Libor, while CLOs are priced at three-month Libor – and the discussion on replacing Libor will only exacerbate it.
“To mitigate the basis risk mismatch in 2022 (between loans and CLOs), we expect most managers and equity investors to rate, refinance or reset trades by 2021,” said wrote BofA strategists Chris Flanagan, Pratik Gupta and Siddhant Mohanty in a research note last week. “We believe this uncertainty could create some volatility in spreads at the end of 2021 as the market tries to reach consensus.”
The preferred Libor replacement benchmark for CLOs and loans would be a forward-looking version of the guaranteed overnight funding rate, known as the SOFR term, but the Alternative Benchmarks Committee convened by the Reserve federal government said more work needs to be done to recommend it. He might not be ready anytime soon.
Read more: The absence of a SOFR term puts the benchmark at a disadvantage
Some other areas of securitization, such as commercial mortgage-backed debt sold by Freddie Mac, have already used average SOFR for some offerings. But this form of benchmark may not be ideal for CLOs given the basis risk.
BofA maintains its forecast of $ 360 billion in CLO sales this year. That breaks down into $ 140 billion for new issuance and $ 220 billion for refinances and resets combined.
Resets for Octagon Credit, First Eagle Alternative Credit and Wellfleet were among those priced this week, while refinancings for Cerberus Loan Funding and Aegon were also completed.
Reset transactions differ from refinances in that issuers are able not only to revalue the price at a lower rate, but can also change various characteristics of the existing CLO in different ways, including shortening the maturities. CLOs typically last around four to five years before their managers sell the portfolio, pay the CLO bondholders, and give the remaining cash to investors in the riskier equity portion of transactions.
Even if the term SOFR gains traction in the industry, it would require a so-called credit spread component that should be factored in, BofA said. However, this credit spread would be priced and as Covid-19 demonstrated, “banks and other lenders are susceptible to much more variability in credit costs during times of stress.”
Therefore, a number of credit sensitive rates are being considered as alternatives to Libor. New benchmarks include Ameribor, the ICE Bank Yield Index from ICE Benchmark Administration Ltd. and the Bloomberg Short-Term Bank Yield Index. BSBY is administered by Bloomberg Index Services Ltd., a subsidiary of Bloomberg LP, the parent company of Bloomberg News.
Read more: BOE Warns Against Credit Sensitive Libor Replacements
Given the overall uncertainty and confusion surrounding the potential benchmarks that will be discussed for the remainder of this year, it is possible that there may be a short-term lag where loans and CLOs refer to benchmarks. different in 2022, although “ultimately we think they will converge,” BofA said.
There could also be a dispersion of preferences within the investment community for benchmarks: for example, US banks may prefer a credit-sensitive rate, while some asset managers would prefer a rate tied to their costs. pension.
Moreover, the basis risk would be even higher than it normally is for new issues of CLOs that increase their assets in 2021. “These CLOs would likely have mainly Libor-linked loans and liabilities linked to one another. hint, “the analysts wrote.
Finally, in a rising interest rate environment, the three-month Libor and the one-month Libor generally increased, resulting in volatility in the distributions of CLOs.
Relative value: timeshare ABS
- Deutsche Bank AG analysts appreciate timeshare ABS, research note released Wednesday
- Analysts are enjoying the value proposition, with consumers looking to resume their vacations as vaccinations continue and the country begins to reopen
- “We think it makes sense to trade off improving credit for spread by lowering the cap structure,” analysts wrote. “Timeshare BBs were recently valued at 270 bps versus swaps in the new issue market, a recovery of 125 bps versus the BBB class and 175 bps versus the single class A” “
- With weighted average lives of around three years, timeshare ABS currently occupy the sweet spot of the 12 basis point swap curve against T-bills, analysts said.
“We are seeing a record influx of potential borrowers every day and our monthly numbers are among the highest we have ever seen,” said Dan McSherry, chief financial officer of lender Bankers Healthcare Group, an ABS issuer, speaking on the expected significant peak. in consumer spending this year. BHG provides both consumer and business loans to healthcare professionals as well as other high income professionals in a variety of fields, used for everything from working capital to debt consolidation. “Over the past year, there are people who haven’t left home and spent, and with the continued expansion of the US economy this year, there is a lot of pent-up demand. . “
Pending ABS deals include Encina Equipment Finance (mid to high value equipment), Avant (consumer loan), America Honda Finance Corp (auto premium), Navient (refi private student loan), GM Financial (auto leasing premium) , Verizon (device payment), Automotive Rentals (fleet rental) and Santander Consumer (automobile subprime).
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