CLO new issuance still solid but forecast to slip; spreads expected to narrow by year-end

By Rebecca Melvin

New York, April 24 – Amid continuing solid supply – there were three new issues priced this past week in the U.S. CLO market plus one refinancing – market players generally anticipate new issue volume will decrease in the second quarter and that spreads will come in from current levels.

CLO new issue volume in March marked an all-time high, and year-to-date issuance stands at about $41 billion, according to Prospect News’ data. But the CLO primary appears to be running out of collateral to sustain the current pace, J.P. Morgan Securities LLC’s Jacob Kurosaki wrote in a note Friday.

“Unless loan supply radically changes, it seems likely that CLO volume will be lower in Q2,” the JPMorgan analyst wrote.

As of April 23, loan volume was $66.7 billion for the year to date, compared to $218.6 billion for the same period last year, according to JPMorgan.

Meanwhile, Wells Fargo analysts Dave Preston and Jason McNeilis, gleening sentiment from this week’s industry conference, wrote in a note Friday that market players were quite bullish on spreads, with conservative estimates at 135 basis points for AAA tranches by year-end and more bullish forecasts for 125 bps or tighter by year-end. The analysts said they are in the 130 bps to 135 bps camp.

The currently depressed level of new loan issuance was cited for the tightening forecasts, along with expectations for a drop in the number of managers able to issue CLOs.

The sentiments were rounded up from investors and managers attending the fourth annual IMN Investors’ Conference on CLOs & Leveraged Loans in New York on Monday and Tuesday.

“One of the highest conviction trades was expected tightening in CLO 2.0/3.0 mezz given a light expected forward new issue calendar, and relative cheapness to underlying leveraged loans, which have tightened 69 bps from the 2015 wide on Jan. 6,” JPMorgan’s Kurosaki wrote.

There are positive technical factors forecast for the CLO market for about two years, and the Wells Fargo analysts said they believe AAA CLOs offer unmatched risk/return. Nevertheless some investors may drop out as spreads tighten.

Other changing dynamics may be more CLO refinancings as strong demand for CLOs continues in the face of depressed loan supply. These refinancings could promote a change among the investor base for CLOs.

Investor demand for refis is because they are shorter bonds, Wells Fargo’s Preston told Prospect News via e-mail. “The weighted average life is two to three years shorter. Some investors want shorter bonds. If you look at the filings of some big, short duration funds like Pimco, you might find those refis. The tighter spread is because they are shorter.”

Structure shift

Also this past week more managers and investors were discussing a possible increase in issuance of CLOs with longer non-call periods and longer reinvestment periods. The typical structure currently is for two years of call protection and four-year reinvestment periods. But there have been some deals recently with a three year non-call period and a five year reinvestment period.

This structure with longer non-call and reinvestment periods may become more common, sources said. Equity investors want short no call periods and long reinvestment periods. Debt investors want more call protection and shorter reinvestment periods. So it is sort of a compromise way to deal with risk retention, Wells Fargo’s Preston said.

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