Blame it on the New York Giants' Super Bowl victory or a streak of luck at the blackjack tables, but panelists at last week's American Securitization Forum's annual conference in Vegas were optimistic about liquidity returning to certain parts of the ABS market, particularly the CLO space.
CDO panelists across the board voiced their enthusiasm about the strength of CLOs, as well as their relative value given their currently depressed spread levels amid the expected default rate.
A conference participant touted CLOs as not only a new frontier in securitization but as the only frontier in the CDO market. Another attendee said his firm was moving aggressively into the CLO market because it is the only CDO structure that investors are currently interested in.
Investors abandoned CLOs last Summer not because of fundamental problems with the product's credit or structure, but rather because of a heightened risk aversion to structured products altogether, CLO market participants said. "From my perspective, this is the first time in 21 years on Wall Street that you have a performing asset class where the investor base has disappeared," said panelist Thomas Inglesby, senior managing director at GSC Group.
CLO spread volatility was the number one reason behind the disappearance of the investor base, said panelists, who cited a recent JPMorgan poll of CLO investors. Buyers were troubled that liability spreads lacked standardization.
Other concerns about CLOs are headline risk and a lack of understanding by senior management that these structures are fundamentally different from ABS CDOs. Market value CLOs that are close to hitting their triggers also cause trepidation among investors, several panelists noted. Forced selling would create a supply overhang that would cause the value of other collateral to fall.
Adding to the list of troublesome factors, riskier lending practices such as covenant-lite loans could significantly reduce recoveries since they lengthen the time a company must endure financial trouble before investors are able to intervene.
But a covenant-lite loan is not a "subprime loan," said panelist David Netjes, chief operating officer at KKR Financial. He maintained that covenant-lite loans issued by large companies will perform better than loans issued by smaller companies that have covenants. This is because many of these covenant-lite loans were issued by large and financially strong companies that had the bargaining power to eliminate covenant packages, he said, adding that covenants do not fix bad management teams or bad business models.
CLO collateral origination is also different. Rating agencies are given full access to a company's balance sheet and are able to directly communicate with senior management, as opposed to relying on reps and warranties as with ABS CDOs.
However, luring investors back to the market will take some time, as many wait for help to determine exactly how CLOs' underlying loans will fare. This could come with a pickup in the default rate, a CLO panelist said.
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