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Citi Leads CLOs as `Better Mousetrap' Resets Take Off

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Citigroup Inc. led in U.S. collateralized loan obligations by market share last year as sales surged 65% from 2016 to about $120 billion, according to data compiled by Bloomberg.

The momentum in CLO sales is expected to continue this year as global demand for the floating-rate product grows amid investors’ hunt for yield. The evolution of the market last year to include resets of older deals has given buyers even more paper to satiate their thirst for returns.

“The CLO sector continues to provide attractive investment opportunities,” said Adam Hagfors, chief investment officer and managing partner at Silverpeak Credit Partners, which invests in CLO equity. “It is very resilient. It always had the refi optionality built in, but the addition of reset technology — and there are multiple forms of resets taking place — shows that it can be an almost permanent-capital vehicle.”

“Resets are indeed a better mousetrap that the market has gotten very comfortable with,” said Amir Vardi, managing director and structured products portfolio manager of the Credit Investments Group at Credit Suisse Asset Management.

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Citigroup was the top underwriter of U.S. CLO resets with a market share of approximately 21.7%. U.S. reset volume in 2017 was $62.2 billion, according to data compiled by Bloomberg.

Managers are getting creative with how they structure and employ documentation to allow for further resets, Hagfors said. Some are finding ways to reset CLOs that have previously undergone a Crescent-letter refinancing, which is typically prohibited by the documentation. The latest trend is to call the old deal, and transfer the collateral and majority equity to a new special-purpose vehicle.

Some managers are choosing shorter reinvestment and non-call periods, depending on their view of when they think the credit cycle will turn, Vardi says. In other words, now that managers will always have the opportunity to reset a deal, they can try to time the credit cycle by tweaking the terms of extended transactions to their liking.

Greater Demand

Investor demand for CLOs is likely to remain broad-based in 2018, a team of Nomura analysts led by Paul Nikodem wrote in a Nov. 17 research note. They see increased participation from money managers and insurance portfolios domestically, and a pickup in overseas demand from China and Korea in particular.

“We expect continued increases in net demand from China and Korea for CLO investment-grade tranches, given that these investors generally do not hedge their currency exposure and there is a meaningful spread pickup for U.S. CLOs vs. Asia credit,” Nomura’s analysts said. Japanese investors are likely to maintain their allocations “but are unlikely to be significant net adders” due to declining currency-adjusted spreads.

CLOs issued in the fourth quarter had the tightest cost of debt of any post-crisis quarterly issuance vintage, Wells Fargo & Co. analyst Dave Preston said in a Jan. 2 research note. “The average CLO portfolio weighted average spread dropped by 30bps between year-end 2016 and year-end 2017.”

Potential Record Year

Analysts see $90 billion to a high of $125 billion in new CLO issuance for 2018. If bullish sentiment prevails, the market will test, and may break the $124 billion record for issuance set in 2014.

Resets are expected to increase while refinancing volume may decrease since most vintage CLOs that fell under the Crescent-letter risk-retention exception have already been refinanced. An estimated $60 billion to $70 billion of CLO resets, similar to last year’s supply, are seen for 2018.

U.S. CLO refi volume was approximately $103.3 billion in 2017, according to Bloomberg data. Morgan Stanley was the top U.S. underwriter with a market share of 18.7 percent.

—With assistance from Femi Olanipekun and Eugene Revyakin.

—Read Citigroup to Pay $285 Million to Settle SEC Charges on CDO Deal on ThinkAdvisor.

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