Spreads on collateralized loan obligations CLO spreads may have tightened quite a bit over the last two years, but they still have a long way to go, according to panelists at the American Securization Forum’s annual meeting.
Interest rates on sub-investment grade loans are still relatively attractive and corporate defaults are still quite low, but the main reason panelists expects CLO spreads to continue tightening is that they have some catching up to with spreads on other kinds of structured products.
“If you compare you’re paid on a risk basis,” for the triple-A rated tranches of CLOs and some other kinds of securitizations, “it’s not even close,” according to Leland Hart, a managing director at BlackRock.
Hart, who was speaking an ASF panel this morning, said the limited supply of corporate loans available to be securitized, versus some other kinds of assets, will only contribute to the spread tightening.
How much could CLO spreads tighten this year? Another panelist, Gagan Singh, chief investment officer at PNC Bank, pointed out that spreads on new-issue triple-A tranches of CLOs are currently around Libor plus 139 bps; while that’s much narrower than at this point last year, when they were closer to Libor plus 150 bps, it’s still rich compared with triple-A tranches of commercial mortgage backed securities. The latter are pricing in the range of Libor plus 70 bps.
Even if corporate loans and commercial mortgages are different asset classes, Gagan said, that kind of spread differential is unlikely to be sustained.
Referring to a side that showed Wells Fargo’s prediction for CLO issuance in 2013 at the high end of the range, Hart said “The demand side” – across the capital structure, from AAA to equity – “is not in question. What determines whether we see $50 billion or $70 billion (of issuance) is the availability of loans and the increased use of warehousing.”
“If that (the warehousing) is taken care of, even Wells’ projection could be on the low side,” Hart said.
Hart predicted that the European CLO market “is going to try to get back on its feet” in 2013, despite the fact that capital retention provisions in the region “are opaque.”
He also predicted that secured bonds will play an increasingly important role in the CLO market. CLO documents typically stipulate that the majority of assets, often 90% or more, be invested in senior secured loans. But Hart said new deals could carve out bigger investment buckets for secured bonds. That’s, both because they are becoming more plentiful and because investors are realizing that they offer the same protection as secured loans, even if they are fixed rate, rather than floating rate.
Finally, Hart predicted that some of the CLOs issued over the past two years could be refinanced to take advantage of the subsequent narrowing in triple-A spreads.