The risk premium that investors demand for holding CLOs continues to decline as refinancing activity continues to dominate the new issuance, and the trend looks set to continue heading into the final two months of the year.
According to the Loan Syndications and Trading Association, yield spreads on the least risky notes issued by collateralized loan obligations, those rated triple-A, has narrowed to an average of 147 basis points, the lowest level of 2016 and in from 160 basis points in May.
One eye-opening deal was across the pond, where BlackRock’s priced the triple-A tranche of its €400 million European CLO II at 98 basis points – the tightest spread on a senior note of a CLO since the financial crisis.
“Both U.S. and European CLOs are testing lows for spreads,” the trade group stated in its weekly newsletter on Friday.
On both sides of the Atlantic, the spread narrowing has been “most pronounced” on the investment grade mezzanine paper, according to a report published this week by Deutsche Bank. The pricing gap between ‘AAA’ paper with those of both ‘AA’ (secondary market spreads of 175-225 basis points) and ‘A’ rated notes (240-300 basis points) is at the smallest levels in the post-crisis era.
The spread basis between ‘BBB’- and ‘BB’-rated tranches, meanwhile, remains “historically wide” of 300 basis points since late fall 2015, as investors remain skittish about riskier CLO tranches.
A major driver to tightening spreads is from the influx of new refinancing deals, which results in little net new supply. According to Deutsche, $3.6 billion of CLOs were refinanced in October, almost doubling the volume in the first nine months of the year to expand total refi volume to $7.2 million, through Oct. 18.
More deals are expected to be refinanced as managers scramble to re-work before risk-retention rules take place on Dec. 24. Concerns have been raised that deals refinancing after that date my no longer be grandfathered from the rules requiring managers to hold 5% share of the notional value of a CLO in order to align their interests with those of investors.
The LSTA points out deals are also driven by investors who bought deeply discounted mezzanine notes earlier this year, and are looking to cash in.
Managers who are refinancing are finding extremely favorable terms in the current market. Ten CLOs have been refinanced at AAA spreads below 130 basis points this year, including three in October: CIFC Funding 2012-III and Dryden XXV Senior Loan Fund (each 120 basis points) and MJX Assets’ Venture X CLO (122). Over the last two months, managers in 11 refinancings have achieved coupon reductions between 12 and 30 basis points.
Reset volume has surpassed $8 billion on the year, with all but three of the 16 deals through Oct. 21 having been closed since Sept. 13. Rather than pursue lower coupons, these CLOs sought and received extensions to their original reinvestment periods, from 15 months to four years.
Two of the reset deals were 2013 vintage transactions – Apollo Capital Management’s $559 million ALM VIII CLO and MJX Asset’s $554 million Venture XV CLO – which were able to extend reinvestment periods by four years despite having a year or more left on their original periods.
New volume issuance is on pace to decline slightly from September levels, according to Deutsche. Two deals pricing this week - - brought month-to-date volume to $4.3 billion. While in line with monthly levels from April to August, it would be down from the $8.2 billion in September issuance.
At $53 billion through Thursday, the volume of CLO issuance in the U.S. is 37% behind the same period last year, according to the LSTA. The 2015 volume levels exceeded $98 billion, the second-highest volume level in the market’s history.
October’s issuance included CVC Credit Partners’ $717 million Apidos XXV transaction (CVC’s third CLO of the year) that was priced through Bank of America Merrill Lynch, and Sound Point Capital Management’s $715 million Sound Point CLO XIV with Credit Suisse as the bookrunner. Both deals were the largest of the month.
(Sound Pount XIV follows just two months after the closing of Sound Point XII in August, as Sound Point Capital apparently passed on structuring an unlucky ‘XIII’ deal. The distressed-debt specialist has issued four deals since December 2015).
Alcentra issued its first CLO since September 2015 with the $413 million Shackelton 2016-IX transaction through Morgan Stanley. American Money Management (AMMC CLO 19, sized at $460 million) and Aegon USA Investment Management (Cedar Funding 6, totaling $498 million in notes) each priced their second deals of 2016. AMM’s deal was priced through Mitsubishi UFJ, Aegon’s through Jefferies.
The $480 million BlueMountain 2016-3 transaction led by Barclays and a new deal from GSO/Blackstone represented the third 2016 CLO deal for each alternative management issuer – although Blackstone’s deal was its first through the Burnham Park CLO platform in a $550 million transaction via Wells Fargo.
The lone middle-market CLO to be issued was NewStar Financial’s $506 million NewStar Berkley Fund CLO, priced through Citigroup.