US CLO Managers See Smooth SOFR Transition – Finance and Banking

Almost five years after regulators first began phasing out
LIBOR, the US CLO market’s first few months of activity in 2022
saw a series of successful new issues fully referencing the Secured
Overnight Financing Rate (“SOFR”). After an unprecedented
year of CLO issuance in 2021, this helped to inject considerable
positivity into the transition to the new reference rate and it is
clear that managers are beginning to successfully adjust to life
after LIBOR.

Of course, there had been considerable apprehension in terms of
how the CLO market would handle the switch to the new benchmark and
a number of deals were pushed to completion ahead of LIBOR
discontinuation at the end of 2021, in anticipation of potential
issues. Any concerns that the market would not comfortably digest
the new CLOs with SOFR-linked liabilities, however, have now been
assuaged with this good start to the new era.

Pricing of the initial SOFR CLOs was relatively in line with
expectations, with Triple A notes generally in the low to mid 130
basis points above three-month SOFR range.

Taking some early examples from January 2022: 

• Neuberger Berman Loan Advisors’ CLO 47 priced at +130 basis
  points on its US$384 million Class A notes; 




• Static deals were issued by Palmer Square Capital Management
  and Fortress Credit Investments, with the US$502.6 million Palmer
  Square CLO 2022-1 and the US$348.95 million middle market FCO XVII
  CLO respectively; and




• The Zais Group issued the five-year US$409.4 million ZAIS
  2022-18 CLO, AGL CLO Credit Management brought a US$506.4 million
  deal and AllianceBernstein launched a US$411.43 million reset of AB
  BSL CLO1 deal. The US$762.3 million Boyce Park CLO managed by
  Blackstone CLO Management priced just inside +130 basis points for
  the Triple A notes

The presence of static deals among the early SOFR supply is
perhaps not especially surprising, given that the underlying
collateral is still adjusting to the new landscape and the
availability of SOFR loans is still relatively limited. 

There has been a notable trend of shortened non-call periods in
the SOFR deals, which would facilitate early refinancing, such as
the one-year non-call period on the Fortress deal. This appears to
be another indication that the market is still adjusting to SOFR
and arrangers are conscious of the potential need to reset
transactions in order to improve their financial mechanics. It is
likely the market will see some significant refinancing activity in
the first quarter of next year as a result.

Interestingly, a small number of CLO managers have already
incorporated applicable margin reset (“AMR”) provisions
into their documentation, which allows them to refinance debt
within a CLO while keeping the underlying loans in LIBOR. The AMR
provisions allow managers to use an online auction process, which
also cuts costs for managers sourcing loans, as it is treated as a
secondary market transaction rather than a primary deal. Reports
indicate there are a handful of CLOs which will exit non-call
periods this year that are eligible for AMR refinancing.

Having previously examined some of the fallback language
included in our clients’ new CLOs, in anticipation of the LIBOR
discontinuation, it emerged that having initially favoured
supplemental language, with the inclusion of specific trigger
events as well as mechanisms for negotiating a new reference rate,
the trend moved towards hardwired language with clear triggers and
defined successor rates and spread adjustments. As the
discontinuation date moved closer, deals tended towards a hybrid
method, which included hardwired fallback language with a waterfall
that could be implemented without investor consent, with managers
having the flexibility to choose and implement an alternative
reference rate.

Widening spreads in the market, however, amid heightened macro
concerns and circumstances globally, also has the potential to
impact CLO refinancing activity. Research¹ 
suggests some CLOs could be out of the money before the end of
year, compounding the increased cost of liabilities with the market
transitioning away from LIBOR and possibly incurring the
Fed-recommended 26.2 basis points above-market credit spread
adjustment.

In the context of the positive start to the replacement of LIBOR
with SOFR in new CLO deals issued at the start of this year, the
Maples Group is pleased to have acted in a legal and fiduciary
capacity on all of the new SOFR US CLOs to price during January
2022. While we anticipate that further adjustments to the new
regime will play out over the course of this year, we will continue
to update our clients on any trends or technical changes that
become apparent in the market as the transition evolves.

For more information on the replacement of LIBOR with SOFR,
please click here to get in touch with our
Structured Finance team.

Footnote

1. The Risks to CLOs from Credit Spread Adjustments
– Barclays Credit Research

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.