Has CLO issuance hit a speed bump?
Just two weeks ago, Wells Fargo upped its full-year forecast for issuance collateralized loan obligations by $25 billion to a record $150 billion, citing ripe market conditions for new managers entering the market thanks to the absence of risk-retention requirements, plus a “strong appetite” for equity positions by risk-tolerant investors.
The volume of new-market CLOs ballooned to $71 billion through the end of May - nearly matching the full-year forecasts of ratings agencies and bank research outfits just six months ago amid a glut of new deals.
But worries that momentum would slow have seemingly materialized. Since mid-May, issuance has “slowed down a tad,” including last week’s holiday-shortened market period in which only two new-issue CLOs priced – making it the smallest weekly volume for primary deals since January, according to JPMorgan.
The full-month volume of $10.7 billion in deals – excluding refinancings and resets – was also the fourth consecutive monthly decline in volume after a 2018 high mark of $14.7 billion in new issuance in February.
The slowdown is largely the result of the combined effects of a slowing speculative-grade corporate loan issuance (down 30% on the year), heavy refinancing and reset volume ($63.6 billion) of existing CLOs absorbing new collateral, as well as aggressive competition for supply by exchange-traded and mutual loan funds. Actively managed funds added $9.7 billion in net new loans year-to-date through June 4, reports JPMorgan.
The two deals closing last week were the $610.9 million Octagon Investment Partners 37 (May 29) with a triple-A coupon spread of 102 basis points over three-month Libor, and the $712.4 million Madison Park Funding XXVIII that Credit Suisse Asset Management priced at 102 basis points over 3M Libor.
While the $71 billion of year-to-date volume of $71 billion is 91% ahead of last year’s pace, JPMorgan points out that figure includes $16 billion in “re-issue” CLOs.
Reissued CLOs have emerged as a 2018 trend through which managers are recycling older deals – in particular portfolios that were refinanced in 2017 – into new securities as a workaround from regulatory restrictions that were placed on them as a means to refinance without jeopardizing grandfathered risk-retention exemptions.
While those portfolios were refinanced into lower prices, their terms were frozen from further refinancing activity as part of a one-time measure allowed under a Securities and Exchange Commission no-action guidance letter. With risk retention no longer applying to CLOs through a February federal court decision, managers are seeking to dismantle those 2017-deal restrictions by reassigning the underlying loans to new portfolios that lack such restraints.
Despite the new-issue slowdown, JPMorgan still forecasts a “robust” volume for the year, with an expected range of $115-130 billion for the “true new issue” CLOs outside of reissues. JPMorgan also expects recent spread-widening trends to reverse, with the average 102 basis point spread on AAA paper shrinking in a “relatively modest move” to sub-90s basis points.
“Today’s very strong economic numbers – that U.S. unemployment is at the lowest level since 1969 – buttress the case for projecting another two Fed rate hikes in the second half of the year,” the report stated, “which if realized should boost the bid for low-risk floating-rate assets such as CLO AAAs.”