Managers putting tighter squeeze on CLO Triple-A spreads
Several broadly syndicated CLOs issued by long-time collateralized loan obligation managers were priced this week at some of the market’s tightest spreads over the last two years, inside of 120 basis points.
On Wednesday, Oak Hill Advisors priced its $438.75 million OHA Credit Partners XIV transaction at 116 basis points on the senior Class A notes; that was just days after Carlyle Investment Management and CIFC each priced AAA spreads at 118 basis points and Octagon Credit Investors at 119.
Another deal up for pricing, GoldenTree Asset Management’s $600 million US CLO 2 transaction, already has an assumed coupon of 116 basis points, according to presale reports from Moody’s Investors Service and Fitch Ratings.
Only eight other deals have priced inside of 120 basis points this year, between April and June.
Market observers and participants say the spread narrowing reflects a wave of demand from institutional investors, both domestic and international, that has fed a 78% year-to-date surge in CLO issuance over the same period a year ago.
“To be sure there have been a handful of sub-120 prints over the last few months, but it certainly seems in the last week to two the entire stack has moved inward," said Gretchen Lam, portfolio manager for Octagon. "We think that’s a function of the fundamental and technical picture, in which there is a lot of money globally which has asked for this paper.”
Oak Hill and GoldenTree would each share the narrowest spread achieved in the market since Gallatin Loan Management’s CLO VIII transaction that priced at 105 basis points on Sept. 21 (the lowest-priced deal in 2017), according to Thomson Reuters LPC data.
Of the 10 CLOs that have priced in October (excluding middle-market CLOs), the average AAA spread is 121.3, according to LPC data. If that mark holds, it would be the fourth consecutive month of declining spreads in CLO senior notes, which averaged 123 basis points in September.
Spreads since January 2016 have averaged 142.9, with a high mark of 164 basis points in May 2016.
Triple-A rated paper has become attractive to investment-grade yield investors who," more and more...have been highlighting the relative value of the triple-digit spread," said Darrell Wheeler, global head of structured finance research at S&P Global Ratings. "There are just no other products that have that much carry, float with rates and a triple-A rating.”
Lam points out investors see the floating-rate AAA CLO notes as "particularly" attractive since a large component of the return is derived from three-month Libor, which has risen 36 basis points this year while the AAA discount margins on the three-year-old JPMorgan CLO index (CLOIE) have fallen from 145 to 115 basis points since January. “While you’ve seen 30 basis points of tightening on the spread, you’ve seen 36 basis points of increase on Libor," said Lam. "Tell me another AAA-rated or investment grade-rated credit product that on an absolute basis is yielding more today than it was on Jan. 1.”
Tightened spreads at triple-A and lower tranches of a deal can lower the costs for managers who are facing increasing stress on weighted average spread tests in their portfolios, due to the falling yields they are receiving from leveraged loans that have refinanced at a breakneck pace this year. Some $660 billion of loans have repredied through the third quarter, and averaging $58 billion a month through mid-October, according to JPMorgan.
The tightened spreads mean lower returns for AAA investors (2.91% year-to-date, according to JPMorgan's CLO index). Some have increasingly been chasing yield in the riskier mezzanine debt or equity ownership tranches of CLOs as tightened senior-note spreads allow for more cash flow to subordinate levels of the capital stack. Spreads have tightened at those levels, as well. (The lowest-rated debt 'B' tranche spreads, for example, have shrank from a 1,010 basis point difference in January to 762, cutting returns of 12.33% to 9.76%).
Month-to-date, 12 new-issue CLOs (including two middle-market deals) have priced totaling $6.13 billion.
GoldenTree Loan Management US CLO 2 would best the price it achieved for its first deal of the year, which priced at Libor plus 124 basis points in March. GoldenTree 2.0 is coming to market with a longer weighted average life (9.1 years as opposed to 8 on its US CLO 1) to the deal, and a reinvestment period that stretches to 5.25 years in the latest transaction.
CLO issuance of $87.5 billion is up 78% from last year’s pace of $49.2 billion, according to JPMorgan, and comparable to the early fourth-quarter level of $87 billion in 2013. CLO issuance was at $100 billion in mid-October 2015, and $124 billion at this point in 2014.