Monoline Wraps Influencing CLO Double-B Spread Movements, Sources Say

A so-called wrapper on European CLO double-B tranches was a “catalyst” for the tightening spreads at the start of the year, a syndicate banker told Octus, formerly Reorg.

This mechanism allows investors to carry mezzanine CLO tranches at an investment-grade rating.

“You have a pretty price-insensitive whole-tranche buyer looking to lift paper on those parameters, a construct where they get a much higher rating for this paper at double-B spreads,” the banker said.

One double-B buyer has been using the instrument while a second investor is exploring the same option, according to several sources.

The indicative mid-spread of double-B tranches in the secondary market tightened by 45 bps from Euribor+610 bps at the start of the year to 565 bps in mid-Feb, according to P&G Alternative Investments.

Then volatility in the broader market caused a widening to 630 bps at the end of last week.

The double-B wrapper was not the sole reason for the tightening, although it contributed. Spreads on other European CLO debt tranches followed a similar trend. Relative to levels at the end of 2024, double-B spreads outperformed single-Bs and triple-Bs in mid-February but underperformed tranches rated single-A and higher.

In the primary market, most double-B tranches priced between 570 bps-600 bps in December. In mid-February, Sound Point achieved the tightest print in the year to date at 460 bps.

A wrapper is a bilateral agreement between the buyer of a double-B bond and an insurer who guarantees the repayment of the notes in case of default. In return, the investor is permitted to exchange the bond risk for the counterparty risk, which is usually double-A for insurance firms. The investor receives the bond coupon and pays the insurer a running premium for the guaranty.

Alternatively, wrappers can be integrated into the structure of the deal at issuance. In that case, the debt is issued as a guarantied bond and the insurer premium paid as part of the waterfall.

Assured Guaranty is the most widely known provider of financial guaranties for CLO bonds both in the United States and in Europe.

“We are seeing continued interest and receptivity despite a tighter credit spread environment,” said Jeffrey Farron, managing director at Assured Guaranty. “Capital continues to be a focus for both banks and insurance companies, and exposure limit management is absolutely a focus for banks in particular.”

Investors rely on guaranties for one of three reasons, Farron told Octus.

Some investors, primarily banks and insurance companies, are using wrappers to manage internal limits on their exposure to certain asset classes, insurers or sponsors.

The guaranty can also help banks and insurers reduce their risk-weighted assets, which are the exposures used to calculate how much capital they must hold to lower their risk of insolvency. This is especially relevant to European insurance companies under Solvency II rules for regulatory capital.

The third purpose of the guaranty is true credit risk mitigation, where the investor benefits from the ratings uplift and credit protection on the underlying asset. Assured is rated AA by S&P Global Ratings and AA+ by KBRA.

In the case of the recent double-B wrapping in Europe, limit relief is the likely motivator, unless the investor is a bank seeking capital relief, a lawyer told Octus.

The buyer can use the guaranty to manage exposure limits to sub-investment-grade debt, rather than to certain industries or managers. CLO portfolios are diversified across sectors, and the European market offers enough issuance to avoid high manager concentration.

While Assured does not wrap mezzanine tranches, a range of firms are able to do so, according to several sources.

“Investors occasionally ask for insurance on mezzanine bonds, too, although Assured Guaranty only offers guarantees on investment-grade debt,” Assured’s Farron said.

A sell-side researcher told Octus that any insurer of an adequate rating can put such a guaranty.

The wrapper concept goes back to the 1970s, when credit insurers known as monolines originally guaranteed bonds issued by municipalities. When structured finance boomed in the 2000s, they increasingly insured collateralized debt obligations and participated in credit default swaps.

The financial crisis in 2008 nearly wiped out the monoline industry and led to stricter regulation. Wrappers have been used in the CLO market throughout the years after the crisis but at a lower volume and mostly attached to investment-grade tranches, according to market sources.

A portfolio manager at a firm that manages and invests in CLOs said the wrappers on double-B tranches “sounded like a discussion we had with [an arranging bank] in 2023.”

A syndicate banker confirmed that there was demand for such guaranties when inflation drove interest rates higher following the invasion of Ukraine, which pushed spreads dramatically wider.

“It’s something that happens on the fringes,” they said. “It definitely makes sense when spreads are wider since it’s usually structured as a percentage of the spread.”

In late 2022 and early 2023, double-B tranches on many CLOs were issued with coupons in the mid-800s.

“It sporadically comes up,” a second CLO lawyer said. “I’ve looked at it a couple of times over the last few years … It doesn’t surprise me if there is someone doing it again.”