High investor demand for collateralized loan obligation paper is squeezing spreads to their tightest levels in more than a year, even as improving monthly CLO issuance has reached its highest level of 2016.
According to Wells Fargo research, primary issue ‘AAA’-rated spreads between the cost of debt and the investor yield reached an average of 145 basis points last week, the tightest for the most senior CLO tranches since July 2015. They have narrowed sharply from the 190 basis-point area that reflected the lackluster demand and CLO issuance trends in February.
Buyers of CLO notes, which are backed by leveraged loans to high-risk speculative-grade companies that are securitized into tranches of varying ratings and risk levels, are snapping up lower-rated paper as well. The ‘AA’-rated notes are pricing at 180 basis points and single ‘A’s’ at a 240 basis point spread, the report authored by structured finance analyst David Preston stated.
The AA’s are “the tightest since summer 2013; single-A spreads are now the tightest in the post-crisis era,” he wrote.
The gap between the ‘AAA’ and ‘AA’ spreads of 35 basis points, and the 95 basis-point spread between triple-A and single-A, are also each at the tightest levels of the post-crisis era.
The tighter loan spreads are likely to continue, "[b]arring macro shock or commodity weakness, strong technicals - including overseas investors looking for yield amid increased quantitative easing efforts," the report stated.
Earlier this month, the Loan Syndications and Trading Associated noted that recent increases in three-month Libor rates were boosting yields for the floating debt instruments of CLOs – providing an attractive option for investors on the potential returns of senior and mezzanine notes in CLOs.
New U.S. CLO issuance volume through Aug. 26 totaled $41.1 billion in 99 deals, less than half the $83.8 billion issued at the same point last year. The total amount of new CLO issuance in August was $7 billion involving 16 deals, according to JPMorgan High-Yield and Leveraged Loan Research. The $7 billion is the highest level of monthly issuance on the year.