CLO Refinancing and Resets
CLO equity investors can significantly boost returns through two mechanisms: refinancing (replacing debt at tighter spreads) and resets (extending the reinvestment period). These transactions typically occur 2-5 years post-closing and can add 100-200 bps to equity IRRs.
Refinancing (Refi)
Definition
Replacing existing debt tranches with new debt at lower spreads (tighter pricing), reducing the CLO's cost of capital.
Example
Original CLO (2020): $300M AAA @ SOFR + 160 bps
Market spreads tighten (2022): AAA now pricing at SOFR + 130 bps
Refinancing transaction:
- Issue new $300M AAA @ SOFR + 130 bps
- Use proceeds to call (repay) old AAA @ par + small premium (e.g., 101 cents)
- Annual savings: $300M × 30 bps = $900K
- Impact on equity IRR: +80-120 bps
When Refinancing Occurs
- Timing: Typically 2-3 years post-closing when market spreads have tightened
- Trigger: Current debt spreads 25+ bps wider than market
- Requirement: Portfolio must be healthy (passing coverage tests, low CCC exposure)
Impact on Debt Holders
- Called at par (or small premium): Receive 100-101 cents
- Lose future spread income: Forced to reinvest at lower market yields
- Why they accept: Deal terms allow equity to call after non-call period (typically 2 years)
Resets
Definition
Extending or restarting the reinvestment period and/or pushing out the final maturity date. Often combined with refinancing.
Example
Original CLO (2018):
- Reinvestment period: 2018-2023 (5 years)
- Legal final maturity: 2030
Reset transaction (2022):
- Extend reinvestment period: 2022-2027 (5 more years)
- Push maturity: 2030 → 2035
- Often includes refi of debt at tighter spreads
Why Equity Pursues Resets
Extending the reinvestment period dramatically boosts equity returns:
- Maintains leverage: Without reinvestment, CLO deleverages as loans prepay (reducing equity cash flows)
- Extends distribution period: 5 more years of equity distributions
- Captures spread arbitrage: Continue earning spread between loan yields and debt costs
- IRR impact: Can add 150-300 bps to equity IRR
Impact on Debt Holders
- Extended maturity: Investment horizon pushed out 3-5 years
- Spread compensation: Debt holders often receive 10-25 bps wider spreads as compensation
- Vote required: Typically requires majority consent from each tranche
Refinancing vs. Reset vs. Refinancing + Reset
| Transaction | What Changes | Equity Benefit | Debt Impact |
|---|---|---|---|
| Refinancing Only | Debt spreads tighten | +50-120 bps IRR | Called at par; lose yield |
| Reset Only | Reinvestment period extended | +100-200 bps IRR | Maturity extended; may receive wider spreads |
| Refi + Reset | Both debt and reinvestment | +150-300 bps IRR | New debt at tight spreads but extended maturity |
Market Trends in Refis/Resets
- 2020-2021: Heavy refinancing activity as spreads tightened post-COVID
- Peak refi year: 2021 ($100B+ of CLO debt refinanced)
- 2022-2024: Reduced activity as spreads widened due to rate increases
- Typical refi window: Years 2-5 post-issuance
Key Takeaways
- Refinancing = lower debt costs (boost equity returns 50-120 bps)
- Resets = extend CLO life (boost equity returns 100-200 bps)
- Combined transactions most valuable (150-300 bps to equity IRR)
- Debt holders called out of attractive yields (reinvestment risk)
- Require healthy portfolio and favorable market conditions