CLO investors are ending 2018 concerned about the market. But many are having difficulty pinpointing what is keeping them up at night.
Investor appear to losing the fervor that drove new issuance for much of the year to record levels. December's $4 billion of primary volume is the lowest monthly total of the year, and AAA spreads have reached their widest level of the year at 128 basis points, according to Wells Fargo.
Last week, a Wells Fargo report detailed a slightly pessimistic vibe that has overtaken CLO buyers, despite strong deal performance levels amid a low-default horizon.
"Our main takeaway is that larger platform, 'real money' investors are cautious, but not overly concerned; the general attitude can be summed up as 'wait-and-see'” along with 'we are worried, but not really sure what to worry about,' " Wells Fargo wrote.
If spreads stay at current levels for the month - and few deals are expected to price in final, holiday-shortened weeks - that would be the widest triple-A mark since May 2017.
November spreads reached an average of 119.7 basis points, the seventh consecutive months of widening, according to Refinitiv.
AAA spreads began the year at 106.4 basis points, according to Refinitiv, and reached their narrowest levels of the year, at 98.4 basis points, in March. They have been widening ever since amid heavy supply of both new issuance and refinancing.
Unlike the spread widening that occurred in the second half of 2015 and the first quarter of 2016, this year's move "appears more driven by technicals rather than actual fundamental worries," Wells' report stated. The technicals include a record sell-off by leveraged loan funds that added up to a net withdrawal of nearly $7 billion from funds since mid-November, including $3 billion this week through Wednesday.
(Loan funds traditionally hold about 10% of the outstanding market for loans, compared with over 50% for CLOs.)
The sell-off has lowered loan prices in the secondary market to their lowest point in over two years. The average price on the JPMorgan Leveraged Loan Index was $95.31 on Thursday, the lowest point since June 2016. As recently as Oct.5 loans were averaging near-par prices of $99.07, according to JPMorgan.
"Loan outflows (often driven by a changing view of value in floating-rate assets), along with the equity markets trying to come to grips with future growth expectations, have driven selling" in CLO securities, Wells reported.
Another factor in slowing investor activity is the pre-holiday slowdown in the market. The two deals that priced Wednesday - Symphony Asset Management's $407 million Symphony CLO XX and TCI Capital Management's TCI-Flatiron CLO 2018-1 ($507 million) - brought the December volume to $4 billion, the lowest monthly mark of 2018.
The relative small number of deals could be skewing prices, since “there haven’t been a lot of data points [from deals] because there hasn’t been a lot to price,” said Lauren Basmadjian, a senior portfolio manager with Octagon Credit Investors.
December is traditionally a month where deals are priced only in the first few weeks "so you have time to ramp," she added. “Everybody’s waiting for January to see where the market is.”
Even with a slow month, the CLO market has already set a volume record for yearly output at $129.6 billion through Wednesday, besting the 2014 level of $124 billion.
