Middle-market CLOs back on pace for near-record year

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The rebound of middle-market CLO issuance this month has put the market on pace for the second-largest volume since 2006, according to Wells Fargo.

Three portfolios of small/medium enterprise commercial loans totaling $1 billion have priced so far in August, pushing the year-to-date total to $8.3 billion across 15 deals. That's as high as the full-year 2016 total. It more than triples the year-to-date issuance through the mid-point of August 2016.

The spurt of activity this month is all the more notable because not a single deal priced in July, MidCap Financial Services Capital Management and Madison Capital Funding each issued their third CLOs of the year, pricing in the first two weeks in August. the Woodmont 2017-3 deal managed by MidCap (controlled by Apollo Capital Management) is a $353.3 million portfolio; Madison issued MCF CLO VII, a $301.76 deal that brings Madison’s total CLO assets under management to $1.3 billion.

The kickstart to the third-quarter issuance arrives as investor demand for the middle-market CLOs continues to grow. More of the MM CLO deals in 2017 have been characterized with larger and upsized portfolios (averaging $381 million, up $20 million in 2016) and double the number of CLO managers launching deals this year (10) compared to the five managers active at this time last year.

MM CLOs typically pay higher coupons that the senior notes of broadly syndicated CLOs: the average spread on the AAA paper in a middle-market CLO was 162 basis points over Libor as of Aug. 11, compared to 121 basis points for BSL CLOs.

At its current pace, 2017 could see the second-largest volume of middle-market CLO issuance since $20.3 billion was issued in 2006.

The outstanding middle-market CLO market grew to $31 billion as of the end of June, Wells Fargo reported, which is 6.8% of the total outstanding CLO volume, according to Wells. (Thomson Reuters LPC figures showed $458.5 billion in total outstanding CLO volume as of July 31).

The MM CLO market continues to grow despite the fact that the high volume of vintage 1.0 middle-market CLOs issued before the crisis are maturing out of the market: the total of 1.0 portfolios is shrinking $550 million a year, with Wells projecting that the entire 1.0 market to be runoff by year’s end.

The middle-market CLO 2.0 pipeline replacing those deals is being fed by a growing pipeline of middle-market loans that have totaled $79 billion year-to date.

Middle-market institutional loan issuance is up to $13 billion year-to-date. Most of the activity ($12.3 billion) comprised of the larger $100 million-$500 million loan segment.

This is due partially to the more aggressive leverage levels resulting from leveraged buyouts, the report stated. The next-highest middle-market institutional volume was $11.8 billion in 2007.

As with major corporate leveraged loans, spreads have tightened from the year before, with an “all-in” spread level now below 600 basis points, according to Wells. Newer vintage CLOs are reducing their exposure to high-risk C-rated loans (usually indicative of likely default), with 2014-2016 deals having Caa-rated baskets between 9% and 13% – compared to 14% in 2013.

Covenant lite is also becoming more of a factor, Wells reported, with 40% to 50% of all middle-market loans classified as cov-lite. The trend is more pronounced with larger middle-market loans in which 71% are lacking traditional maintenance covenants.

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