News
Euro CLO equity outperforms
European CLO equity spreads have experienced a notable turnaround, from a negative -10.5% price return in 2015 to an 8.8% price return in 2016. Indeed, based on a sample of 63 post-crisis deals, JPMorgan figures show that European CLO equity total returns average 32.21%.
Every CLO in the sample shows a positive total return ranging from 54.3% to 10.1%. JPMorgan CLO analysts note, however, that the 2015 vintage underperformed due to a higher dollar price.
European CLO equity overcame several macro hurdles and outperformed in 2016, in particular - with cash-on-cash returns standing at 18%, relative to an annualised average of 15% since the start of post-crisis issuance. This performance coincides with European loan defaults hitting post-crisis lows in 1H16, ending at 2.40%, compared to the 4.13% average since 2010.
The JPMorgan analysts suggest that the key threats to European CLO equity returns are spread compression and lack of collateral. The S&P LCD primary European leveraged loan spread of 370bp, as of the end of February, is down 121bp year-on-year, while institutional loan volume is €15bn, as of 3 March.
Given that total return-benchmarked investors are enjoying the highest post-crisis CLO equity prices since 1Q15, the investment profile is evolving into a carry trade with less price upside. The analysts indicate that investors should consider relative valuations of CLO single- and double-B tranches to the extent that forecasted equity yields are less attractive in some scenarios.
They point out, however, that CLO equity offers "one of the highest levels of upfront carry achievable" in Europe and there is an upside from a refinancing and/or reset perspective to cope with asset market conditions.
Of 93 European CLO 1.0 deals, 39 have paid down since last year, indicative of the rapidly diminishing CLO 1.0 market. Cumulative cashflow returns since inception for European CLO 1.0s that remain outstanding are 115%.
Paid down European CLO 1.0s have seen cashflow returns of 100%. The 2002 vintage has seven deals classified as paid down and the highest cumulative cashflow returns at 131%, but six 2001 vintage deals had the highest annualised cashflow returns at 17%.
In the CLO 2.0 universe, cash-on-cash returns were 18.5% in 2016, slightly behind last year's 18.9% - with the 2014 vintage also outperforming the 2015 vintage in 2016. The analysts note that this could be due to the absence of Euribor floors in the 2014 vintage.
With three-month and six-month Euribor still negative, CLO equity in deals without Euribor floors saw cash-on-cash returns in 2016 that were 0.5% higher than their floored counterparts. Additionally, non-floored 2015 vintage CLO equity saw cashflow returns of 23% versus 18.2% for floored deals. The analysts expect the number of non-floored European deals to decrease going forward.
In terms of European CLO equity liquidity, BWIC volumes decreased 18% year-on-year from 2015 to €562m in 2016, with an estimated 27% that did not trade. This compares to US CLO equity BWICs of US$2.9bn in 2016.
Last year was the first in which the majority of equity BWICs were from post-crisis CLOs, as pre-crisis CLOs continue to pay down.
13/03/2017 15:30:02
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