(Bloomberg) -- One of the last hurdles preventing riskier companies from slashing borrowing costs in an already red-hot leveraged loan market is crumbling.
Managers of collateralized loan obligations, the biggest buyers of U.S. leveraged loans, have started to give in to an unprecedented surge of repricings of the debt they hold in their portfolios. More than $175 billion of CLOs have refinanced in the last 12 months, up from less than $10 billion in the prior one-year period, according to data compiled by Bloomberg.
These refinancings could further strengthen the hands of borrowers, allowing them to demand even more rate cuts from their creditors who have little choice other than to say yes. Unlike junk bonds, loans are relatively easy to prepay, giving companies the option to refinance with a new group of investors. About $525 billion of loans have repriced during the last 12 months, compared to $130 billion in the prior one-year period, Bloomberg data show.
There is a usually a floor on loan spreads “but that floor is moving lower because CLOs are refinancing and resetting," said Brit Stickney, portfolio manager of Allianz Global Investors' income and growth fund team, which manages $39.5 billion in assets. This approximate minimum paid on leveraged loans, which was at about 250 basis points more than the London interbank offered rate last year, has now tightened to 200 basis points, said Stickney.
About $200 billion of loans in the past 12 months were issued at spreads of less than 250 basis points, up from $2.5 billion in the prior one-year period. First Data Corp. is in the process of repricing the spread on a $3.89 billion term loan to 225 basis points from 250 basis points. Dell Inc. obtained a $5 billion loan in October that pays 200 basis points above Libor, and American Airlines Group Inc. repriced its $990 million term loan to 200 basis point from 250 basis points.
"CLO refinancings to a lower financing cost does give managers more leeway to accept a lower weighted averaged spread loan" for their CLO, said Pratik Gupta, CLO analyst at Nomura.
Riskier companies have always taken advantage of the relative ease of prepaying loans to reprice the debt whenever markets got frothy. But there was a limit to how low they cut borrowing costs without stirring opposition from CLOs. Now as CLOs reprice, their role as a bulwark against rates on leveraged loans being squeezed too much has diminished.
Managers, whose profits were under pressure by loan repricings, are finding relief by cutting spreads on CLOs they already sold.
"The CLO arbitrage still works given the spread tightening on the liability side," said Steven Wagner, senior portfolio manager at Federated Investors, who added, 200 basis points “seems like a bit of a floor."
Benefit Street Partners last month lowered the top-rated liability prices by nearly half for a CLO it originally issued in 2015, reducing the rate by 75 bps to 78 bps. Onex Capital Partners refinanced a $654.5 million CLO from 2015, cutting the rate on the top-rated portion of the fund by 70 bps to 80 bps. Similarly, PGIM in September reset a 2012 CLO, cutting 48 basis points on the AAA spread to 90 basis points.
"The trend of CLO refinancings and resets is here to stay because it's a response to the loan collateral repricing," said Maggie Wang, CLO analyst at Citigroup Inc., who predicts $150 billion of CLOs will lower their promised returns to investors each year going forward. “That's what's driving it.”
There seems to be little impediment to CLO managers further refinancing and cutting payments to their investors. CLO bonds still offer better yields than comparably rated corporate bonds. As CLOs tighten, so can the spreads on the loans they hold.
"If they do, the underlying loans can go lower too," said Allianz's Stickney.
--With assistance from Charles Williams and Lara Wieczezynski
To contact the reporters on this story: Lisa Lee in New York at llee299@bloomberg.net, Adam Tempkin in New York at atempkin2@bloomberg.net.
To contact the editors responsible for this story: James Crombie at jcrombie8@bloomberg.net, Faris Khan, Andrew Dunn
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