Post-reinvestment is a natural part of the CLO life cycle. But in stronger market conditions, managers tend to reprice or reset their deals, pushing out maturities on the bonds that finance the vehicle and extending their ability to actively manage their loan portfolio.

But because of tough market conditions — significantly higher interest rates, extreme volatility and concerns around credit quality of highly leveraged companies — a larger than usual proportion of CLOs are expected to enter the post-reinvestment stage.

“If you priced a deal in 2020, you’re not refinancing or resetting that deal in this market, said one CLO manager.

This has the potential to drain liquidity even further from the leveraged loan market, which is already under pressure. CLO managers are by far the biggest investor base for leveraged loans; with more of them unable to trade freely, conditions could tighten further.

According to a research report published last month by BofA, some 40% of both broadly syndicated and middle-market CLO deals are scheduled to enter post-reinvestment by the end of 2023.

“With the outlook for spreads not expected to improve any time soon, we anticipate reset volumes to be very low,” the analysts wrote.

That would have an inevitable impact on trading in the loan market: all together, those CLOs account for nearly 30% of the loan market’s buyer base, according to the BofA analysts.

“More deals going into post-reinvestment is already impacting liquidity,” said another CLO manager. “There’s a huge bifurcation and flight to quality in the loan market, and that will only continue as this trend plays out.”

In Europe, the reinvestment crunch has already begun to impact borrowers. For weeks now, Keter, an Israeli company that makes plastic outdoor furniture, has been struggling to push through an amend-and-extend of its €1.2bn TLB, which matures in 2023.

As our colleagues in London recently reported, one of the challenges the company is facing is that many of the CLOs that hold the loan are already outside of their reinvestment periods, and therefore unable to participate in the deal.

Get shorty

This trend is exacerbated by recent deal-structuring habits in the CLO market: notably, the fact that shorter-dated CLOs (otherwise known as “print and sprint” deals) became more common during the height of the pandemic.

That trend cooled off in 2021. But as those shorter-dated pandemic CLOs approach the end of their reinvestment periods, their managers’ ability to reset or refinance has been crippled by rising rates and a pullback in investor demand for certain parts of the CLO capital stack.

Last month, Japanese savings bank Norinchukin (also known as Nochu) signaled a slowdown in its CLO investments when it pulled out of a CVC deal just before it was due to price. The bank is a lynchpin buyer of senior CLO debt.

US banks have also cut back on investing in triple-As, further depressing demand. And in the middle of the capital stack, recent proposals from a key insurance industry regulator could make it less cost-effective for insurers to invest in mezzanine CLO debt.

This can all make it harder to form new CLOs, although issuance this year has still been historically robust. But crucially, it also reduces the ability of managers to extend reinvestment via resets or repricings.

“We still need to see the same volume of refis and resets as we did in 2021 to address all these vintages from COVID,” said another CLO manager. “But loan prices are lower, and liabilities are wider, so there’s no incentive to reset.”

Recently, some managers have returned to print-and-sprint structures, aiming to make a quicker return on their investments and counter rising spreads. This suggests the current reinvestment crunch could return in a couple of years (unless the ability of reset or refinance has increased by then).

Grading down

This reinvestment crunch is an unwelcome development, given that CLO managers are already grappling with a higher rate of downgrades. Most CLOs have limitations on how many triple-C loans they can hold, so when downgrades increase they come under greater pressure to manage such exposures.

According to last month’s BofA report, some 70%-80% of the 2023 and 2024 loan maturities that have been downgraded this year have been downgraded to CCC or lower.

Such companies are typically limited in their ability to refinance upcoming maturities, but CLO managers that hold their loans are often willing to agree to a maturity extension; however, this option is usually dependent on CLOs having healthy WAL test scores, which is unlikely for vehicles approaching the end of their life.

As managers find themselves subject to these greater trading restrictions (or as those still within reinvestment attempt to address problem credits before their trading ability is curtailed) the loan market’s lowest-rated credits are likely to feel the most pain.

“Triple-Cs are already suffering and trading down, but credits at the lower end of the single-B bucket will also start to suffer,” said one of the CLO managers.

Companies that have suffered multi-notch downgrades are also point of concern, said the other manager.

“These situations are going to become a lot more prevalent — they’ll make the WARF rate go up, and impact MVOCs,” he said, highlighting two of the tests that govern CLO managers’ behavior, such as their ability to trade or make distributions to investors.

He pointed to Weber Grills as an example. The NYSE-listed outdoor grill manufacturer — which saw a bump in sales during the pandemic and was valued at nearly $5bn in its 2021 IPO — was downgraded from B to CCC+ by S&P this summer, after it missed earnings expectations.

The primary loan market has reopened somewhat in recent weeks, but stressed credits like this may have to look to less traditional methods to shore up their finances. Weber, for example, is reportedly in discussions about a debt financing from its sponsor, BDT Capital Partners.

Others could consider stressed exchanges like Vericast’s recent transaction, or regular amend-and-extend deals — but as the Keter situation shows, the CLO reinvestment crunch could significantly hamper such efforts.