Issuance of European CLOs is running ahead of last year’s pace, and analysts at Bank of America expect this to continue, despite a recent drop in the origination of new loans.
In a report published this week they said that the 9.6 billion issued this year through July beats the 6.9 billion that came out in the same timeframe last year.
The analysts see the pace remaining more or less the same for the rest of 2015, reaching a total of 18 billion, 24% higher than 2014’s 14.5 billion.
How can managers keep printing CLOs when issuance of European institutional loans, the raw material for these deals, is down 26% in the first seven months of the year, to $27.1 billion?
Bank of America thinks that loan origination will start growing again, thanks to more M&A activity.
The character of the CLO market has changed somewhat this year from last. Volatility in the second half of 2014 pushed managers to reduce deal size and leverage. This has held even with the pick-up in activity. The average CLO in the first half of 205 was 419 million, compared to 398 million in 2014, according to BAML analysts. The average debt/equity ratio, meanwhile, eased to 8.3x from 8.6x.
Another area of change: currency denomination. The BAML analysts said that they believe all European CLO tranches last year were in euros. Not so this year, with at least of couple of deals containing non-euro notes. Cadogan Square CLO VI, priced in May, had sterling tranches, while Black Diamond 2015-1, printed in July, has U.S. dollar tranches.
The analysts said that non-euro tranches can help a manager dispense with cross-currency swaps if the underlying assets are non-euro denominated to begin with.
This year has also seen a slight uptick in manager diversity, with two deals coming from new managers, from zero last year. The analysts expect more, provided they can persuade investors they can skillfully source and manage loan portfolios.
Other features haven’t changed. Non-call periods and reinvestment periods, for instance, have stayed at two years and four years, respectively, for post-crisis European CLOs. The U.S., in contrast, has seen more change, with non-call periods cut down to 1-1.5 years for a number of deals in the last year. The idea has been to give equity investors a chance to refinance deals before risk retention rules in the U.S. take effect at the end of 2016. More recent deals in the U.S. have seen non-call periods move in the reverse direction, pushing out as far as three years.
The European market has seen spread tightening in the mezzanine tranches of CLOs this year, a trend fueled by new investors, including credit funds and family offices.
Greek-related anxiety forced spreads wider in mid-summer but the BAML analysts see demand rising again, in time for post-summer issuance: “New investors continue to be attracted to the CLO market, with the focus currently on lower mezzanine tranches and equity.”