Camulos Capital closed Camulos Loan Vehicle 1 last Wednesday, kicking off the second quarter with positive news in the way of new issuance. The $731 million cash flow CLO, which is the first CLO for the manager, offered triple-A to double-B paper in five tranches priced at 85, 250, 300, 500 and 800 basis points, according to ASR Scorecards database. Morgan Stanley underwrote the deal, and Citigroup is the trustee.
Though issuance was still meager, the CLO market did take baby steps in the first quarter. U.S. CLO volume totaled $5.3 billion in 12 deals, with one transaction closing in January, three in February, and eight in March, according to data provider Dealogic. However, compared with the 43 deals totaling $22 billion issued in the first quarter of 2007, this year has begun with a 72% drop in deal volume and a 76% fall in value.
Market participants have long been pointing the finger at the complete absence of triple-A investors as the cause of the decline in volume. Without them, any new issuance activity in the CLO market can't happen, said a CDO trader. Exacerbating the situation are spreads on leveraged loans, which are relatively tight when compared with CLO liabilities, the trader said. "In order for the arbitrage to make sense, we would need to see leveraged loans trading in the low 80s as opposed to the low 90s."
Furthermore, the pricing dislocation has made the secondary market a much more attractive option for CLO investors. "It is hard to imagine why people would buy [triple-A paper] at 150 basis points [in the primary market] when it can be bought at 350 basis points in the secondary market," the trader said.
Yields are also higher in other sectors right now, making them much more attractive than a CLO investment. "People who are looking for triple-A exposure can pick up triple-A CMBS with an unbelievable yield," said Paul Forrester, a partner at Mayer Brown, noting that CLO equity tranches used to be able to provide that yield.
Given the current economic situation, issuance is expected to remain sluggish at least for the next quarter if not the rest of the year, market participants agreed.
And Then There Were Five
The number of U.S. CDO managers on the league tables, which include CLO issuance, were predictably few this quarter, with only five banks issuing deals, according to Thomson Financial. Citigroup Global Markets claimed first place with a 38% market share, despite coming to market with only five deals totaling $2.3 billion.
Second place finisher Morgan Stanley issued three deals totaling $1.3 billion and claimed a 21.4% market share, while JPMorgan Securities issued three deals totaling $1.2 billion with a 20.6% market share, putting the bank in third place.
Barclays Capital and Lehman Brothers placed fourth and fifth, respectively. Barclays Capital claimed a 10% market share with one deal totaling $608 million, and Lehman also took a 10% market share but with two smaller deals totaling $605 million.
As of last Monday, the U.S. pipeline stood at $7.6 billion, including $6.6 billion of CLOs, according to JPMorgan. The bank noted that at least five CLOs have priced in recent weeks, with decent interest at the double-A and single-A levels, mainly from other CLOs attempting to fill structured product buckets.
New CLOs this quarter also came as the result of static exits, Forrester said. Since a number of market-value CLOs or TRS synthetic portfolios fell into default or were subject to triggers, these deals were refinanced into special purpose vehicles and then structured like static cash-flow transactions. Three of the transactions that came to market this past month were restructurings, according to a recent Wachovia Securities report.
There may also be a continuation of static transactions as a result of the current loan overhang. While some of this debt has gone away as a number of LBO deals have blown up, banks will not be able to clear a significant portion of debt from their balance sheets without CLOs, Forrester said. He noted that static deals may be done in order to get rid of some of this
The market has also seen some activity in nonrated bespoke types of CLO transactions, in which a bank will put together a portfolio for a hedge fund client that functions a lot like a CLO, except that it is not a rated transaction and, in effect, the only beneficial owner is the hedge fund, said Joel Telpner, partner at Mayer Brown. These deals are private and would not be counted in league table issuance.
Hedge fund interest in loan opportunities and reverse inquiry deals has shown early signs of promise for CLO issuance, Forrester said. In a reverse inquiry deal, the equity investor will begin the deal process by calling an arranger and having them bring in potential managers for the transaction. These deals are driven entirely by equity and are done with the expectation that prices will recover by the term of the deal and defaults will not be as bad as the current pricing would indicate or imply.
But for now, most loan opportunities funds are waiting for signs that the market is close to bottoming out. "People are out there raising money, they're just not spending it yet," Telpner said. The current surge in litigation will also complicate the market's attempt to move forward, he noted.
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