Onex deal marks a 1st wave of incoming Sofr-linked CLOs

The reset of Onex Credit Partners’ OCP CLO 2015-10 is a milestone involving the first CLO priced with a liability tranche linked to the Libor-replacement Sofr benchmark.

The deal is expected to be the first of a wave of deals coming to market in the coming two months using the Sofr reference rate, as managers transition away from pricing deals to three-month Libor — deals the market fully expects to disappear altogether after Dec. 31.

"We should start to see Sofr deals pricing in later November to December," said Scott Macklin, senior vice president and director of leveraged loans for asset manager AllianceBernstein. "I think once the spigot is opened, the water is going to start flowing strongly."

“You could probably see deals pricing in Sofr in December, and then closing in the new year as people can get comfortable with it,” said Neil Weidner, a securitization and structured finance partner with Cadwalader Wickersham & Taft LLP.

Weidner confirmed that the law firm is assisting in ramping up new-issue CLOs from warehouses that will use a three-month term Sofr benchmark plus a spread adjustment.

The $418.9 million OCP CLO 2015-10 reset, via Nomura, included a single Sofr-linked tranche among the seven note offerings. The triple-A $84 million Class A-2-R2 tranche included a spread of Sofr+124 bps, compared to the L+109 bps spread for the $176 million class A-1-R2 tranche, the other tranche rated Aaa by Moody's.

The deal was set with a one-year non-call and a three-year reinvestment period.

Although CLO managers are not under any legal mandate to switch to an alternative reference rate, their primary investor base — U.S. banks — are under heavy regulatory pressure to cease entering into Libor-based deals by next year, when the U.K.'s Financial Conduct Authority will cease publishing most Libor tenors.

In October, Federal Reserve Board Vice Chairman for Supervision Randal Quarles underscored those expectations by warning that banks could be subject to supervisory actions if they delay the Libor transition.

While some Sofr-based deals are being proactively structured as they ramp up from warehousing, according to sources, others may have no choice but to utilize term Sofr as the year's end approaches.

Any deals pricing to Libor will likely have to price by November in order to meet a December closing date, and market observers say the window for launching Libor-based deals before Dec. 31 has likely already been closed on deals that have not yet completed precursory stages such as a rating-agency review.

"If it is maybe three weeks, maybe four weeks, to close a CLO from pricing, and maybe two or three weeks from launching a CLO to pricing it, you can see that the calendar quickly constricts" for new Libor-based deals in 2021, said Dave Preston, head of structured credit research at AGL Credit Management.

On Oct. 22, Barclays Credit Research issued a report titled "Libor’s Sunset Presents Challenges on the Horizon" stating that the Libor deadline "should drive a pull-forward of CLO issuance from early 2022 into November and possibly the first week of December" by issuers pushing to issue deals with securities that match the rates of loan assets expected to continue pricing to Libor until at least mid-December.

With warehouses currently at record levels," the report stated, "there should be no shortage of CLOs attempting to close ahead of the end-of-year deadline in order to have liabilities match the vast majority of assets from a reference rate perspective."

For the near future, CLO managers will have few Sofr-based loans available to ramp into their deals.

According to LCD data, seven Sofr-based loans totaling $5.97 billion have been offered up in the leveraged-loan market in recent weeks. Traverse Midstream Partners LLC's $1.35 billion term loan B and Heubach Group’s $610 million first-lien term loan, for example, have been completed with spreads priced to Sofr as well as credit spread adjustments that account for differences with Libor.

As CLOs issue new deals next year with assets mismatched to the CLO securities benchmark, Barclays noted this "could cause some supply and demand idiosyncrasies."

But the report added that "the results are likely to be short term."