The Resurgence of the CLO Market

Meredith Coffey, LSTA Moderator

John Clements Citigroup
David Golub Golub Capital
Bret Leas Apollo
Rob Zable GSO/Blackstone
1
Whats new in CLOsand what does it mean for loans?
CLOs stunning performance to datedo investors care?
What does CLO issuance look like in the near term? The
medium term?
How will changes in CLOs change the loan market?
The $64 billion question: Could regulation squash the CLO
revival?
Outlook or How I learned to stop worrying and love CLOs

2
Section 1: CLO performance and investor base
Brief performance recap
Prices and ratings and lossesoh my!
What do CLO AAA spreads indicate?

New investors?
What makes CLOs attractive?
How has the investor base changed?
What are these new investors looking for?

3
Performance: CLO prices and ratings recover
CLO 1.0 secondary prices recover
P
r
i
c
e

(
%

o
f

p
a
r
)

Source: Citi Research, Moodys
0
20
40
60
80
100
120
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12
AAA AA A BBB BB
CLO AAA notes downgraded, but recover
%

o
f

A
A
A

C
L
O

n
o
t
e
s

4
0%
20%
40%
60%
80%
100%
2
0
0
9
-
0
3
2
0
0
9
-
0
6
2
0
0
9
-
0
9
2
0
0
9
-
1
2
2
0
1
0
-
0
3
2
0
1
0
-
0
6
2
0
1
0
-
0
9
2
0
1
0
-
1
2
2
0
1
1
-
0
3
2
0
1
1
-
0
6
2
0
1
1
-
0
9
2
0
1
1
-
1
2
2
0
1
2
-
0
3
2
0
1
2
-
0
6
2
0
1
2
-
0
9
AAA AA A
BBB Below
Performance: CLO note impairments have been all but
non-existent
Cumulative impairment rate from Jan 1996 to May 2012
Source: Moodys Investors Service
Unimpaired
98.57%
Realized losses at mat
0.78%
Dist. Exch.
0.17%
Market value EOD
0.02%
Other
0.46%
5
Performance: CLO losses lower than most other asset
classes
Five-year cumulative IG loss rates
Source: Moodys Investors Service
L
o
s
s

r
a
t
e

0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
G
l
o
b
a
l

C
D
O
s

e
x

C
L
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s
U
S

R
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/
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d

F
i
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S

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E
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A

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&

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s
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a
-
P
a
c

A
B
S
,

C
M
B
S

&

R
M
B
S
6
CLO AAA spreads remain wider than other asset
classeswarning sign or opportunity?
AAA secondary spreads
Source: Citi
S
p
r
e
a
d

(
b
p
s
)

0
200
400
600
800
Sep-08 Sep-09 Sep-10 Sep-11 Sep-12
CLO AAA Auto AAA
Credit Card AAA Student Loan AAA
7
Section II: How will CLO volumes change?
In the near term
CLO issuance has rebounded
But making the economics work is challenging

In the medium term
How big will issuance become?
Will CLO issuance match CLO amortization?
Where does the CLO market stabilize?
What does this mean for CLOs role in the loan market?


8
CLO issuance is recovering in 2012
Source: Citi
CLO issuance rebounding in 2012.
V
o
l
u
m
e

(
$
B
i
l
s
.
)

0
25
50
75
100
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
1
1
Y
T
D

2
0
1
2
9
CLO issuance climbs in 2012; CLO AAAs fluctuate
Source: Thomson Reuters LPC
CLO issuance rebounding, AAA spreads moving roughly inversely to volume
V
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u
m
e

(
$
B
i
l
s
.
)

A
A
A

s
p
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e
a
d

(
b
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)

100
110
120
130
140
150
160
170
180
0
1
2
3
4
5
6
7
8
J
a
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-
1
1
F
e
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-
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1
2
S
e
p
-
1
2
Issuance Avg AAA spread (excl. MM)
10
In the short term: The arb is challenging
Source: Thomson Reuters LPC, LCD, Citi
CLO AAA spreads widened as loan spreads narrowed counter-balanced by tightening CLO mezz spreads
I
n
s
t
.

l
o
a
n

s
p
r
e
a
d
s

B
B
B

C
L
O


s
p
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e
a
d
s

C
L
O

A
A
A

s
p
r
e
a
d
s

0
20
40
60
80
100
120
140
160
180
0
100
200
300
400
500
600
700
800
900
1000
J
a
n
-
1
1
M
a
r
-
1
1
M
a
y
-
1
1
J
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-
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-
1
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N
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v
-
1
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-
1
2
M
a
y
-
1
2
J
u
l
-
1
2
S
e
p
-
1
2
B+/B "all in" inst spreads
BB/BB- "all in" inst spreads
CLO AAA spreads
11
650
700
750
800
850
900
500
520
540
560
580
600
620
640
660
7
/
1
1
/
1
2
7
/
1
8
/
1
2
7
/
2
5
/
1
2
8
/
1
/
1
2
8
/
8
/
1
2
8
/
1
5
/
1
2
8
/
2
2
/
1
2
8
/
2
9
/
1
2
9
/
5
/
1
2
9
/
1
2
/
1
2
9
/
1
9
/
1
2
9
/
2
6
/
1
2
B
B

s
p
r
e
a
d
s

BBB DMs
BB DMs
In the short term: How do secondary loan prices &
warehousing (or lack thereof) affect CLO performance?
12
Source: S&P/LSTA Leveraged Loan Index, Thomson Reuters LPC
91
92
93
94
95
96
97
1
2
/
3
1
/
2
0
1
1
1
/
3
1
/
2
0
1
2
2
/
2
9
/
2
0
1
2
3
/
3
1
/
2
0
1
2
4
/
3
0
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2
0
1
2
5
/
3
1
/
2
0
1
2
6
/
3
0
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2
0
1
2
7
/
3
1
/
2
0
1
2
8
/
3
1
/
2
0
1
2
Secondary loan bids rally
0%
5%
10%
15%
20%
25%
30%
<
8
0
8
0

t
o

<
8
5
8
5

t
o

<
8
6
8
6

t
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8
7
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7

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2
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4
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1
0
0
>
=
1
0
0
Aug-12
Sep-12
Oct-12
Loan bids climb in CLOs
B
i
d

(
%

o
f

p
a
r
)

%

o
f

l
o
a
n
s

0
50
100
150
200
250
300
2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029
CLOs Outstanding
CLOs in Reinvestment
Medium term: Vintage CLOs will disappear rapidly
B
S
L

C
L
O

O
u
t
s
t
a
n
d
i
n
g
s

(
$
B
i
l
s
.
)

Source: Citi Research
Today
Cumulative decline in CLO reinvestment capacity and CLOs outstanding
13
0
10
20
30
40
50
60
70
80
90
100
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
1
1
Y
T
D

2
0
1
2
2
0
1
3
2
0
1
4
2
0
1
5
2
0
1
6
2
0
1
7
2
0
1
8
CLO issuance has to top YTD 2012 levels
just to offset CLOs going out of reinvestment
Source: Citi, LSTA
CLO issuance: Historical vs. amount needed to replace CLOs going static
V
o
l
u
m
e

(
$
B
i
l
s
.
)

*Assumes post-reinvestment capacity of 50% in year 1, 30% in year 2, 20% in year 3
Hist. CLO iss.
CLO iss needed just to offset
Deals exiting reinvestment period
14
Section III: How a changing CLO market could lead
to a changing loan market
Why CLOs are especially important to the loan asset class
The interplay between vintage and new CLOs
How changing CLO cost of funding will impact loan spreads
Will LIBOR floors stick?
Will CLO baskets ultimately constrain covenant lite loan
issuance...or will baskets constrain CLO performance?
Are Amends & Extends a one-cycle event?

15
CLOs remain the biggest single institutional investor,
Bringing stability to loans for now?
Investor market share in primary
Source: S&P/Capital IQ/LCD
S
h
a
r
e

(
%
)

0%
10%
20%
30%
40%
50%
60%
70%
80%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 1-3Q12
Fin Co Ins Co
Hedge, Dist, HY Fund Loan Mutual Fund
CLO
16
Loan wish lists: Vintage CLOs vs. new CLOs
Vintage CLO wish list

Needs shorter-maturity loans
due to WAL test

Can tolerate lower spreads
due to lower WACC

Limited covenant lite
constraints

Limited Amend & Extend
constraints

And more.
New CLO wish list

Call protection

Can do long-maturity loans

Needs higher spreads due to
higher WACC

Covenant lite constraints

Amend & Extend constraints

And more
17
Loan spreads are much higher than mid-2000s
Any chance they return to those levels?
Source: S&P/Capital IQ/LCD
0
100
200
300
400
500
600
700
800
900
Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
B+/B inst spreads
BB/BB- spreads
Primary institutional term loan spreads
18
S
p
r
e
a
d

(
b
p
s
)

CLO Weighted Average Cost of Capital (WACC)
has climbed markedly
Source: Citi, LSTA
2007s CLO WACC: 44.5 bps Todays CLO WACC: 195 bps
19
Equity
BB - 7.25%
BBB - 5.25%
A - 350 bps
AA - 250 bps
AAA - 140
bps
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Today
C
L
O

c
a
p

s
t
r
u
c
t
u
r
e

Equity
BB - 4.15%
BBB - 2.25%
A - 72 bps
AA -42 bps
AAA - 23 bps
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2007
C
L
O

c
a
p

s
t
r
u
c
t
u
r
e

Higher CLO WACC in 2012 wont support 2007 level
loan spreads
20
Source: Citi Research, S&P/LCD, LSTA
S
p
r
e
a
d
/
W
A
C
C

(
b
p
s
)

CLO WACC vs. BB/BB- and B+/B TLB spreads
0
100
200
300
400
500
600
2007 2012
CLO WACC
BB/BB- TLB spread
B+/B TLB spread
2012 CLO WACC
Cross over investors also likely to leave when loan
spreads get too narrow
Source: S&P/Capital IQ/LCD, LSTA
Loan-bond yield differential has fallen sharply
Y
T
M

(
%
)

21
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
7
/
1
/
0
9
9
/
1
/
0
9
1
1
/
1
/
0
9
1
/
1
/
1
0
3
/
1
/
1
0
5
/
1
/
1
0
7
/
1
/
1
0
9
/
1
/
1
0
1
1
/
1
/
1
0
1
/
1
/
1
1
3
/
1
/
1
1
5
/
1
/
1
1
7
/
1
/
1
1
9
/
1
/
1
1
1
1
/
1
/
1
1
1
/
1
/
1
2
3
/
1
/
1
2
5
/
1
/
1
2
7
/
1
/
1
2
9
/
1
/
1
2
Relative value investors only interested in loans at
certain yield pointswill leave if spreads drop too low
22
Source: S&P/LCD
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
<= B-/B2 or B/B3 or unrated >= B/B2
Loan Fund
Ins Co
Fin Co
Hedge/HY/RV
CLO
S
h
a
r
e

o

n
e
w

i
s
s
u
e

l
o
a
n
s

Hedge funds/HY/RV accounts play small role in higher rated (lower yielding) loans
LIBOR floors have supported CLO equity performance
will they stick?
Source: Thomson Reuters LPC, Citi
LIBOR floors are widespread Supporting strong quarterly distributions in CLOs
F
l
o
o
r

(
b
p
s
)

0%
10%
20%
30%
40%
50%
60%
70%
80%
0
50
100
150
200
250
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Avg. LIBOR floor
% loans with LIBOR floors
%

o
f

l
o
a
n
s

w
i
t
h

f
l
o
o
r
s

CLO Vintage
23
0%
1%
2%
3%
4%
5%
6%
7%
8%
2006 2007 2008 2009 2010 2011
Year of Payment
05 vintage 06 vintage 07 vintage
Q
t
r
l
y

d
i
s
t
r
i
b
u
t
i
o
n

(
%
)

Covenant lite loans return but will new CLO
constraints limit the cov-lite market?
24
Source: S&P/LCD
0%
5%
10%
15%
20%
25%
30%
35%
0
20
40
60
80
100
120
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
1
1
1
Q
-
3
Q
1
1
1
Q
-
3
Q
1
2
Cov lite iss Cov lite market share
Covenant lite issuance and market share
I
s
s
u
a
n
c
e

(
$
B
i
l
s
.
)

M
a
r
k
e
t

s
h
a
r
e

(
%
)

Section IV: CLOs and Regulation
Risk retention
And FATCA
And Volcker Rule

OH MY!

25
0
50
100
150
200
250
300
2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029
CLOs Outstanding CLOs in Reinvestment
FATCA grandfathering ends
FATCA reporting & interest withholding begins
FATCA principal/sales withholding begins
Volcker goes into effect
CLOs (probably) must register/seek commodity pool exemption
FDIC assessments already underway; criteria for new assets change April 13
U.S. Risk Retention: CLOs comply in 2015
Basel III begins
Euro risk retention
Regulation and existing CLO lifecycle
B
S
L

C
L
O

O
u
t
s
t
a
n
d
i
n
g
s

(
$
B
i
l
s
.
)

Source: Citi Research, LSTA
Today
Outstanding and reinvesting CLO s vs. looming regulation
26
Key takeaways
CLO performance was remarkably strong in the Great
Recession
CLO investors realize this and are returning
But not in the same numberswhich means CLO
outstandings may well contract
In addition, the CLO investor base has changed, has different
return needs
Which leads to a higher WACC
Which means loan spreads cannot contract like mid-2000s
And new CLO constraints may lead to a different looking loan
market

27