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Please see the last page of this publication for important disclosures.

September 10 2010
CLO Market Review

CLO Market Review


August 2010
In addition to reviewing the current state of the CLO and loan
market, we review the upcoming wall of loan maturities and its
impact on the CLO market.

„ The CLO market ($260 billion) owns roughly 54% of the outstanding
institutional loan market ($481 billion) of which 69% ($333 billion) is
maturing between 2010 and 2014. In this report, we discuss the
issues, a few likely solutions, and why we believe this will have a
minimal impact on defaults and the CLO market.

„ We believe that the solution will be a combination of amend-to-


extends, bond-for-loan takeouts, and new loan capacity from other
sources. We believe that the wall of maturities will have a minimal
impact on defaults, and as a result, we continue to like CLO equity.

Stocks fell in August on news of slowing domestic and global


economies but the credit markets held up and CLOs continued to
rally towards April’s tights.

„ Stocks fell in August with the Dow Jones Industrial Average falling
4.3% from 10,466 on July 30 to 10,015 on August 31. Likewise, the
S&P 500 fell 4.7% from 1,102 to 1,049 during the same period.

„ August was a busy month for the CLO market with BWIC volume
rising from $819 million in July to $1,246 million in August.

„ As we predicted in our last report, yields on double-B notes tightened


in from 18-22% on July 31 to 17-20% on August 31. During that same
period, spreads on triple-A notes tightened in from 200-275 bps to
200-250 bps, double-A notes tightened in from 450-500 bps to 425-
500 bps, and spreads on single-A notes tightened in from 650-800
bps to 650-750 bps.

„ Our view remains the same as last month: we are medium to long-
term bullish on the loan market and therefore we are medium to long-
term bullish on CLOs up and down the capital stack. Bullish investors
should take advantage of bonds with longer duration as these will
Justin Pauley provide greater price appreciation as spreads tighten.
MBS, CMBS & ABS Strategy
+1 203 897 4619 „ We continue to believe that buy and hold investors should capitalize on
justin.pauley@rbs.com the economic recovery with double-Bs and equity (both low dollar and
strong cashflowing equity). Both trades offer significant upside in the
www.rbsm.com/strategy long term and are likely to continue rallying in the medium to long-term.
The Royal Bank of Scotland

„ Triple-A CLO notes, in or near post-reinvestment, are recommended


for accounts looking for short and safe cashflow as we view these as
money good regardless of economic conditions.

CLO Market Review | September 10 2010


Performance in the loan and CLO market remained relatively
unchanged in August.

„ According to LCD, on average, loan prices were unchanged (from


90.72 on August 1 to 90.72 on August 31). By rating, triple-C loans
fell the most from 80.80 to 79.81 during the same time period. While
loan prices did not rise, they are still higher than 89.84 on June 30.

„ The inflows to high-yield mutual funds fell to $1.52 billion for August
from July’s $2.79 billion. However, $1.52 billion is still much higher
than June’s $262 million. The high-yield bond inflows on August 25
($315 million) represented the seventh straight week of inflows. The
inflows to bank loan mutual funds moved from $296 million in July to
$405 million in August. The $142 million of bank loan inflows on
August 25 represented the eighth straight week of inflows.

„ For the first time this year, the lagging twelve-month LSTA loan index
default rate rose slightly, from 3.47% in July to 3.57% by volume after
Oriental Trading filed a Chapter 11 reorganization plan. Nevertheless,
the default rate is still lower than June’s level of 4.02% by volume. We
believe that the default rate will continue to fall though 2010.

„ Defaulted and Caa1-Ca buckets (our proxy for the triple-C bucket) in
CLOs scarcely budged in August with the default rate moving from
2.8% in July to 2.6% in August. CLO exposure to defaulted assets
remained at 7.4% during the same period.

„ Senior post-2002 Overcollateralization (OC) cushions rose from


12.02% in July to 12.50% in August. Minimum post-2002 OC
cushions (including interest diversion tests) rose from 0.95% in July
to 1.19% in August. We believe the loan market will continue to
improve and OC cushions will continue to grow as a result.

Moody’s steps-up the amount of CLO upgrades in August while


S&P remains silent.

„ Moody’s upgraded 90 tranches from 26 CLOs in August and did not


downgrade any tranches. For perspective, Moody’s upgraded 42
tranches in July.

„ S&P did not upgrade or downgrade any tranches in August. As the


CLO market continues to improve, we believe S&P will likely upgrade
notes later this year.

Citi will arrange another CLO

„ According to CreditFlux, Citi is going to arrange a new CLO for


Guggenheim Investment Management. Guggenheim will retain the
equity and mezzanine tranche of the $592 million deal.

2
The Royal Bank of Scotland

Deconstructing the Maturity Wall


There has been a lot of press surrounding the $325 billion dollars of

CLO Market Review | September 10 2010


loans due to mature between 2012 and 2014. In this section, we
discuss the issues, a few likely solutions, and why we believe this will
have a minimal impact on defaults and the CLO market. The following
analysis is comprised of data from LCD and Intex.

The Problem
To be put simply, the problem is that the CLO market ($260 billion)
owns roughly 54% of the outstanding institutional loan market ($481
billion) of which 69% ($333 billion) is maturing between 2010 and 2014.
Specifically, 43% ($207 billion) is maturing in 2014 and 18% ($88
billion) is maturing in 2013. This problem exists because the market
conditions in 2006-2007 allowed for a great deal of CLO issuance and
thus high demand for leveraged loans.

If these issuers cannot Investors are concerned that issuers will not be able to refinance due
refinance or extend their loan to an insufficient primary CLO market and light demand for leverage
they will be forced to default. loans relative to the number of outstanding CLOs that are ending their
reinvestment period (Figure 1). Moreover, if these issuers cannot
refinance or extend their loan they will be forced to default.

Figure 1: Cumulative Percentage of CLOs Ending Reinvestment


Period by Quarter

120% $250 Billion

100%
$200 Billion

80%
$150 Billion
60%
$100 Billion
40%

$50 Billion
20%

0% $-
Q1-2010
Q2-2010
Q3-2010
Q4-2010
Q1-2011
Q2-2011
Q3-2011
Q4-2011
Q1-2012
Q2-2012
Q3-2012
Q4-2012
Q1-2013
Q2-2013
Q3-2013
Q4-2013
Q1-2014
Q2-2014
Q3-2014
Q4-2014

Source: RBS, Intex

These solutions, discussed Fortunately, there are a few solutions to this problem. These solutions,
below, have helped reduce the discussed below, have helped reduce the 2010-2014 wall of maturities
2010-2014 wall of maturities from $521 billion on 12/31/2008 to $418 billion on 12/31/2009 and
from $521 billion on 12/31/2008 finally $333 billion on 8/20/2010 (Figure 2). The bulk of the reduction
to $333 billion on 8/20/2010. was focused on the loans maturing in 2013, ($174 billion on 12/31/2008
to $88 billion on 8/20/2010).

3
The Royal Bank of Scotland

Figure 2: Distribution by Year Of Maturity ($B)

250

CLO Market Review | September 10 2010


200

150

100

50

-
2010 2011 2012 2013 2014 2015 2016 2017
12/31/2008 12/31/2009 8/20/2010 Pro Forma for HY Paydowns

Source: LCD

Figure 3 shows how the wall of maturities for loans maturing in 2010
through 2014 has been reduced over time.

Figure 3: Reduction in 2010-2014 Maturity Wall by Source ($B)

600

500

400

300

200

100

-
12/31/2008 12/31/2009 8/20/2010 Pro Forma for HY
Paydowns

Source: LCD

Solution #1: Amend-to-Extend


Amend-to-extends have An amend-to-extend is when an issuer amends their loan to extend the
reduced the 2010-2014 wall by loan’s maturity (average 2.5 years) and, in turn, offers to increase the
$37 billion in 2009 and $26 cost of the loan (an average of 132 bps). It is not an optimal solution as
billion YTD 2010. it just pushes the problem down the road but lenders prefer it to
default. Amend-to-extends have reduced the 2010-2014 wall by $37
billion in 2009 and $26 billion YTD 2010. One issue borrowers may run
up against is reluctance from banks to extend the maturity of
borrowers’ loans past the maturities of their bonds. This issue may
force issuers to address their bond and loan maturities concurrently.

Although each deal is different, we believe the majority of CLOs do not


specifically prohibit for amend-to-extends. However, extending the life
of the collateral may cause the weighted average life test, found in
most CLOs, to fail and result in trading restrictions. Many deals allow
for modifications to the weighted average life test with Rating Agency
Confirmation (RAC).

4
The Royal Bank of Scotland

Solution #2: High-yield Bond Takeout


Bond for loan takeouts have A high-yield bond takeout is when a high-yield issuer issues a new
reduced the 2010-2014 wall of bond to retire their outstanding loan debt. This option often costs the

CLO Market Review | September 10 2010


maturities by $24 billion in 2009 issuer more than amend-to-extend because the new bonds yield an
and $31 billion YTD 2010. average of 4.4% more than the loans they retired but will extend the life
of the debt an average of 4.5 years instead of the 2.5 years for amend-
to-extend. Bond for loan takeouts have reduced the 2010-2014 wall of
maturities by $24 billion in 2009 and $31 billion YTD 2010.

Bond takeouts may be more suitable for borrowers than amend-to-


extends for a variety of reasons including:

„ A “Jumbo” (multi-billion dollar) term loan - the institutional loan market


can no longer digest this kind of size.

„ No ability or desire to quickly delever – the prepayment protection


would not be attractive to issuers that want to pay down their debt.

„ Need additional time – issuers may believe it is best to lock in at


today’s rates for longer than 4 years.

Bond takeouts present a difficult issue for CLOs. In addition to causing


large amounts of unscheduled principal payments, they remove
issuers from the eligible pool that managers can choose from. In other
words, CLO managers will have additional cash but less places to use
it. Still, managers receiving par back is preferable to a default. It should
be noted that most deals can reinvest unscheduled principal after their
reinvestment periods if certain conditions are met. However, one
typical condition that most CLOs will fail is that their tranches were not
downgraded by a set amount. If a deal cannot reinvest unscheduled
principal after their reinvestment period, the payments are used to
retire the notes sequentially.

Solution #3: New Loan Capacity from Other Sources


Another possible solution would be adding additional loan capacity
from other sources such as:

„ Loan Funds - As we will discus in greater detail later in this report, loan
funds have had eight straight weeks of positive inflows. This capital
may be put to use to help issuers refinance their outstanding debt.

„ Banks - As the economy continues to improve, banks may ease up


and start lending more.

„ IPO/M&A – Some issuers have filed paperwork for an IPO that may
lead to loan repayment or, at least, improve their balance sheet. In
addition, companies acquired by corporate issuers with cash may
repay.

„ Primary CLO Market – While we expect minimal new issuance until


secondary CLO prices rise enough to make new issue arbitrage
deals more attractive, this maturity issue may drive loan prices down
and act as a catalyst for the primary market revival.

5
The Royal Bank of Scotland

„ Government Programs – If nothing else seems to be working, we


expect that the government may step in and help issuers refinance or
extend their outstanding loans.

CLO Market Review | September 10 2010


Putting it All Together: Our Outlook
Paydowns, partial paydowns, Putting it all together, we see that amend-to-extends, bond takeouts, and
and defaults have contributed capacity from other sources have been taking chunks out of the wall. In
to the reduction by $130 billion addition, paydowns, partial paydowns, and defaults have contributed to
in 2009 and $68 billion YTD the reduction by $130 billion in 2009 and $68 billion YTD 2010 (Figure 4).
2010.
Figure 4: Reduction in 2010-2014 Maturity Wall by Source ($B)

60

50

40

30

20

10

-
Paydowns Partial paydowns HY takeouts Defaults A-to-E
2009 YTD 2010

Source: LCD

Furthermore, 30% of the wall maturing in 2014 is made up of 10 names


and 50% of the wall is made up of the top 31 names (using initial loan
balance, does not account for partial paydowns). Figure 5 shows the
top 10 names, most of which have strong private equity sponsors.
Consequently, a few issuers can make a major dent in the wall.

Figure 5: Top 10 Issuers by Outstanding Loans Maturing in 2014


Issuer Outstanding ($mm) % of Total
1 TXU Corp 16,450 7.3%
2 First Data Corp 11,775 5.2%
3 Tribune Company 7,620 3.4%
4 Univision Communications Inc 7,000 3.1%
5 Community Health Systems Inc 6,465 2.9%
6 Thomsons Learning Co 4,065 1.8%
7 Calpine Corp 4,000 1.8%
8 Avaya Inc 3,800 1.7%
9 Las Vegas Sands Inc 3,600 1.6%
10 Allison Transmission Inc 3,100 1.4%
Total 67,875 30.1%

Source: LCD

6
The Royal Bank of Scotland

At that rate, the wall should be We believe that, at this rate, the wall of maturities will crumble without
reduced to an acceptable size causing the default rate to spike. Figure 6 shows the amount of
by 1Q2012. Therefore, we reductions in the 2010-2014 wall of maturities by quarter. It does not

CLO Market Review | September 10 2010


continue to feel confident in take into account additions to the wall from new deals, facility
CLO equity performance. increases, or amend-to-extends. Using this information, we estimate
that the wall will continue to be reduced by $51B each quarter
assuming the credit markets continue to remain open. At that rate, the
wall should be reduced to an acceptable size by 1Q2012. Therefore,
we continue to feel confident in CLO equity performance.

Figure 6: Maturity Cliff Reductions by Quarter ($B)

80

70

60

50

40

30

20

10

-
3Q09 4Q09 1Q10 2Q10 Jul-Date

Source: LCD

Nevertheless, we do warn that Nevertheless, we do warn that issuers rated triple-C or less may find it
issuers rated triple-C or less difficult to avoid default due to their in ability to access the capital
may find it difficult to avoid markets and investors should avoid CLOs with large triple-C buckets.
default due to their in ability to Figure 7 shows that triple-C and below loans only makes up 5% ($16
access the capital markets. billion) of loans that mature through 2014 whereas single-B loans
maturing through 2014 make up 63% ($211 billion) of the wall.
Comparing to previous years, triple-C or lower on 12/31/2009 made up
$36.4 billion of the wall and on 12/31/2008 triple-C or lower made up
$40.5 billion of the wall through 2014.

Figure 7: Maturity by Corporate Credit Rating ($B)

250

200

150

100

50

-
BBB BB B CCC/CC/C NR
Due Through 2013 Due Through 2014

Source: LCD
7
The Royal Bank of Scotland

Back on Track
Regardless of the performance News of slowing domestic and global economies led stocks to fall in

CLO Market Review | September 10 2010


in the equity markets, the credit August with the Dow Jones Industrial Average falling 4.3% from 10,466
market held up and CLOs on July 30 to 10,015 on August 31. Likewise, the S&P 500 fell 4.7%
continued to rally towards the from 1,102 to 1,049 during the same period (both indices have since
levels we saw in April. rallied). Regardless of the performance in the equity markets, the
credit market held up and CLOs continued to rally towards the levels
we saw in April before news surrounding Europe knocked the CLO rally
off-track.

August was a busy month for the CLO market with BWIC volume rising
from $819 million in July to $1,246 million in August (Figure 8).
Moreover, August, unlike July, did not have any CLO packed
liquidations.

Figure 8: BWIC Volume by Week ($MM)

800
700
600 Stanton CDO Liquidation July 13

500
400
300
200
100
-
1

5
.W

.W
.W

.W

.W

W
W
st.

st.

st.

st.

st.
ly

ly

ly

ly

ly
Ju

Ju

Ju

Ju

Ju

gu
gu

gu

gu

gu
Au

Au

Au

Au

Au
Source: RBS

As we predicted in our last report, yields on double-B notes tightened


in from 18-22% on July 31 to 17-20% on August 31. During that same
period, spreads on triple-A notes tightened in from 200-275 bps to 200-
250 bps, double-A notes tightened in from 450-500 bps to 425-500
bps, and spreads on single-A notes tightened in from 650-800 bps to
650-750 bps (Figure 9).

Figure 9: Timeline of Generic CLO Yields/DM*


8/31/2010 7/31/2010 6/29/2010 5/30/2010
Original Rating Yield / DM Yield / DM Yield / DM Yield / DM
Super Senior AAA 175-200 175-200 200-225 200-225
AAA 200-250 200-275 200-275 225-275
AA 425-500 450-500 450-500 500-550
A 650-750 650-800 650-850 650-850
BBB 12-14% 12-14% 13-15% 14-15%
BB 17-20% 18-22% 20-22% 20-25%
Cashflowing Equity 40s-60s 40s-60s 40s-60s 40s-60s
Non-Cashflowing Equity 10-30 10-30 10-30 10-30

* Generic levels for 2006-2007 paper with 6-year reinvestment periods Source: RBS

8
The Royal Bank of Scotland

„ While we remain neutral in the short-term, we are bullish on the loan


market and therefore we believe that levels up and down the CLO
capital stack will continue to rally in the medium to long-term. Bullish

CLO Market Review | September 10 2010


investors should take advantage of bonds with longer duration as these
will provide greater price appreciation as spreads tighten. Our reasons
for remaining bullish are the same from last month but merit repeating:

„ The entire capital stack costs less than the underlying pool of loans.

„ There are limited forced sellers.

„ There is very little new issuance.

„ CLO performance continues to improve.

„ And there exists a belief in the U.S. economic recovery.

We continue to believe that buy We continue to believe that buy and hold investors should capitalize on
and hold investors should the economic recovery with double-Bs and equity (both low dollar and
capitalize on the economic strong cashflowing equity). Both trades offer significant upside in the
recovery with double-Bs and long term and are likely to continue rallying in the medium to long-term.
equity. Moreover, equity investors will benefit from the excess spreads from
the LIBOR floors in new issue loans (total spreads around 700 bps for
single-B loans).

However, we again caution against CLOs with large triple-C and


defaulted buckets since, because of haircuts, OC cushions in these
CLOs are a lot more sensitive to loan prices and the loan market
remains volatile. In August triple-C prices fell from 80.80 to 79.81. For
comparison, on May 4, 2010, triple-C loans were priced at 86.37.
Failing OC tests may cause cashflows to be diverted away from equity
to amortize the most senior notes. That said, equity, priced at 2.5-3
years of cashflow, remains a solid play as defaults are most likely to
stay low for the foreseeable future, allowing equity holders to clip 20-30
points annually.

Triple-A CLO notes, in (or near) Triple-A CLO notes, in (or near) post-reinvestment, are recommended
post-reinvestment, are for accounts looking for short and safe cashflow as we view these as
recommended for accounts money good regardless of economic conditions.
looking for short and safe
cashflow as we view these as Loan Market Update
money good regardless of
economic conditions. Almost all of the statistics we use to measure performance in the loan
market remained unchanged in August. Given the amount of decline
and volatility in the equity market, we view unchanged as a positive
result. One other positive news item in August is that inflows to bank
loan mutual funds remain strong. Figure 10 shows inflows to bank loan
mutual funds moved from $296 million in July to $405 million in August.
The $142 million of bank loan inflows on August 25 represented the
eighth straight week of inflows. The inflows to high-yield mutual funds
fell to $1.52 billion for August from July’s $2.79 billion. However, it is
still much higher than June’s $262 million and the high-yield bond
inflows on August 25 ($315 million) represented the seventh straight
week of inflows.
9
The Royal Bank of Scotland

Figure 10: High-yield and Bank Loan Mutual Fund Flows ($mm)

4,000

CLO Market Review | September 10 2010


3,000
2,000
1,000
-
-1,000
-2,000
-3,000
-4,000
April 2010 May 2010 June 2010 July 2010 August 2010
High-yield Bank Loan

Source: AMG/Lipper

Despite strong inflows, loan prices on average remained unchanged at


90.72 on August 1 and on August 31, according to LCD (Figure 11).
While loan prices did not rise, they are still higher than 89.84 on June
30. By rating, triple-C loans fell the most from 80.80 to 79.81 during the
same time period. Falling triple-C prices are concerning because of the
impact they have on OC haircuts. The LCDX dropped a few points from
96.58 (spread of 343 bps) on July 30 to 94.78 (spread of 404 bps) on
August 31. During that same period, the CDX IG fell from 99.79
(spread of 104 bps) to 99.34 (spread of 115 bps) and the CDX HY fell
from 97.80 (spread of 555 bps) to 95.89 (spread of 606 bps).

Figure 11: Average Bid Price of S&P/LSTA Leveraged Loan Index

100
95
90
85
80
75
70
65
60
55
3/1/10
3/8/10
3/15/10
3/22/10
3/29/10
4/5/10
4/12/10
4/19/10
4/26/10
5/3/10
5/10/10
5/17/10
5/24/10
5/31/10
6/7/10
6/14/10
6/21/10
6/28/10
7/5/10
7/12/10
7/19/10
7/26/10
8/2/10
8/9/10
8/16/10
8/23/10
8/30/10

ALL BB B CCC Defaulted

Source: LCD

For the first time this year, the lagging twelve-month LSTA loan index
default rate rose slightly from 3.47% in July to 3.57% by volume after
Oriental Trading filed a Chapter 11 reorganization plan (Figure 12).
Nevertheless, the default rate is still lower than June’s level of 4.02% by
volume. As Oriental Trading was already in default on its second lien
the default rate by number of loans was not affected. The lagging
twelve-month default rate by number of loans dropped from 4.91% to
4.66%. We believe that the default rate will continue to fall though 2010.
10
The Royal Bank of Scotland

Figure 12: Lagging Twelve-Month LSTA Loan Index Defaults

12%

CLO Market Review | September 10 2010


10%

8%

6%

4%

2%

0%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Default Rate by Volume Default Rate by Count

Source: LCD

Defaulted and Caa1-Ca buckets (our proxy for the triple-C bucket) in
CLOs scarcely budged in August with the default rate moving from 2.8%
in July to 2.6% in August. CLO exposure to defaulted assets remained
the same at 7.4% during the same period. Figure 13 shows the combined
buckets slightly dropping from 10.2% to 10.0%. This information comes
from trustee reports which are often lagged. For this analysis we included
569 CLOs with an average trustee report date of 7/28/2010.

Figure 13: CLO Combined Default and Caa1-Ca Buckets

16%

14%

12%

10%

8%
6%

4%

2%

0%
Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10
Defaults + Caa1-Ca

Source: Intex, RBS

OC cushions are a good way to measure CLO performance because


the calculation takes into account many variables including triple-C
and defaulted loan exposure and prices. Figure 14 shows senior post-
2002 Overcollateralization (OC) cushions rose from 12.02% in July to
12.50% in August. Minimum post-2002 OC cushions (including interest
diversion tests) rose from 0.95% in July to 1.19% in August. This
analysis includes 474 CLOs with an average trustee report date of
7/20/2010. We believe the loan market will continue to improve and OC
cushions will continue to grow as a result.

11
The Royal Bank of Scotland

Figure 14: Average Post-2002 CLO OC Cushions

14%

CLO Market Review | September 10 2010


12%

10%

8%

6%

4%

2%

0%
Senior OC Cushion Minimum OC Cushion
Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10

Source: Intex, RBS

Tell-tale Signs
In August, Moody’s upgraded Rating actions are typically one of the best and generally most lagged
90 tranches from 26 CLOs and indicators of performance in the CLO market. When Moody’s originally
did not downgrade a single 2,071 tranches early last year, it was right after CLOs hit rock bottom,
CLO tranche turned a corner, and started down the path to recovery. In August,
Moody’s upgraded 90 tranches from 26 CLOs and did not downgrade a
single CLO tranche (Figure 15). They upgraded more than twice the
amount they upgraded in July (42). The majority of these upgrades were
the result of delevering of the tranches and improvements in OC tests.

Figure 15: August Moody’s CLO Rating Actions


Current Rating
Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca WR
Aaa - - - - - - - - - - - - - - - - - - - - -
Aa1 3 - - - - - - - - - - - - - - - - - - - -
Aa2 4 7 - - - - - - - - - - - - - - - - - - 1
Aa3 1 3 2 - - - - - - - - - - - - - - - - - -
A1 1 1 3 1 - - - - - - - - - - - - - - - - -
A2 - - 1 - 1 - - - - - - - - - - - - - - - -
A3 - 1 - 2 4 2 - - - - - - - - - - - - - - -
Baa1 - - 1 - - 1 - - - - - - - - - - - - - - -
Previous Rating

Baa2 - - - - - - 1 - - - - - - - - - - - - - -
Baa3 - - - - - 2 1 3 2 - - - - - - - - - - - -
Ba1 - - - - - - - - 2 4 - - - - - - - - - - 2
Ba2 - - - - - - - 1 1 3 1 - - - - - - - - - -
Ba3 - - - - - - - - - 1 4 3 - - - - - - - - -
B1 - - - - - - - - - - - - 1 - - - - - - - -
B2 - - - - - - - - - - - - - 2 - - - - - - -
B3 - - - - - - - - - - - - - 2 3 - - - - - -
Caa1 - - - - - - - - - - - - - - 1 2 - - - - -
Caa2 - - - - - - - - - - - - - - - - 2 - - - -
Caa3 - - - - - - - - - - - - - - 1 - 3 1 - - -
Ca - - - - - - - - - - - - - - - - - - 4 - -

WR - - - - - - - - - - - - - - - - - - - - -
Source: Moody’s
12
The Royal Bank of Scotland

While S&P has not upgraded any tranches in August, it has not
downgraded any either. We believe that S&P will follow Moody’s and
by this time next year both rating agencies will have similar ratings.

CLO Market Review | September 10 2010


Primary Color
According to CreditFlux, Citi is going to arrange a new CLO for
Guggenheim Investment Management (Figure 16). Guggenheim will
retain the equity and mezzanine tranche of the $592 million deal.

Figure 16: Guggenheim Term Financing LTD

Class Size ($MM) Rating


A 300 Aaa/AAA
B 110 Baa2/BBB
Equity 182 NR

Source: CreditFlux

We believe the CLO market will As we have mentioned in pervious reports, while we expect a few new
eventually come back in order issue deals to price, we do not expect new issuance to return in any
for corporations to grow, meaningful way until secondary CLO prices rise enough to make new
operate, and thrive. issue arbitrage deals more attractive. The recent widening in CLO
liabilities and concerns over the impact of regulatory issues will make it
difficult for new issue deals to come to market in the short-term.
However, we believe the CLO market will eventually come back in
order for corporations to grow, operate, and thrive.

Conclusion
Although the equity markets took a hit in August, the loan and CLO
markets held up. While the loan markets remained relatively
unchanged, CLO levels continued to rally even with a large amount of
supply from BWICs.

We continue to believe that buy and hold investors should capitalize on


the economic recovery with double-Bs and equity (both low dollar and
strong cashflowing equity). Both trades offer significant upside in the
long term and are likely to continue rallying in the medium to long-term.
Triple-A CLO notes, in (or near) post-reinvestment, are recommended
for accounts looking for short and safe cashflows as we view these as
money good regardless of economic conditions.

We continue to be encouraged by performance improvements in the


CLO market and the large number of upgrades by Moody’s. While
many investors have expressed concerns over the approaching wall of
maturities, we believe the impact on the default rate will be minimal and
we remain bullish on CLO equity.

While every month we see more and more news on CLO issuance, we
do not expect new issuance to return in any meaningful way until
secondary CLO prices rise enough to make new issue arbitrage deals
more attractive. However, we believe the CLO market will come back in
order for corporations to grow, operate, and thrive.

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The Royal Bank of Scotland

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CLO Market Review | September 10 2010


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