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July 24, 2020  

CLO Issuers Considering Fixed-Rate Debt

Collateralized loan obligation issuers are taking a fresh look at selling fixed-rate securities.

Such offerings have been relatively rare so far due to the so-called basis risk involved in offering fixed-rate bonds backed by floating-rate assets. That is, issuers don’t want to expose themselves to the possibility that a decline in Libor-based collateral payments would leave them with too little incoming cash to pay interest to investors, whose fixed coupons would remain unchanged.

But with today’s interest rates near zero, that exposure is seen as minimal. And even if prevailing rates enter negative territory, most leveraged loans have “Libor floors” that keep their coupons positive no matter what. Those accounts typically are pegged to three-month Libor.

“The thinking is, you only have 20 bp of downside on the mismatch and a long way on the upside” should collateral rates float higher, one equity investor said.

Indeed, the opportunity to lock in cheap fixed-rate funding is so attractive that several managers are exploring the idea both internally and in conversations with dealers. The only catch may be that, to date, the investor base for such securities has been small.

In most cases, willing buyers have consisted mainly of insurance companies — a large part of the fixed-rate investment community given their fixed-rate liabilities. And their interest has been confined to notes with triple-A, double-A or single-A ratings.

To that end, issuers have occasionally carved out fixed-rate tranches from larger classes at the tops of their deals’ capital structures. “It may be a chicken-or-the-egg problem,” one issuer said. “Our experience is that this interest develops from an investor’s inquiry into us, and not from our marketing.”

Still, the issuer said, “CLO issuers see the benefit as too attractive not to try.”

While the potential volume of new fixed-rate debt is unclear, there’s clearly an opportunity to refinance existing obligations. On July 16, TCW issued replacement notes for the fixed-rate portions of a $408.2 million deal it originally priced in April 2018. Among the new securities, an $18.8 million class of triple-A-rated notes pays 1.9%, versus 3.9%, while a $5 million class of double-A securities pays 2.7%, versus 4.6%. Natixis was the underwriter.

In fact, fixed-rate CLO notes may represent the only near-term refinancing activity given the fact that spreads on floating-rate securities with triple-A grades are wider than they have been for the past three or four years. “The only other reason you could see a refi or reset is if a CLOs gets to the end reinvestment period and the manager might be willing to pay up to extend,” another source said.