After a significant slow down following the economic turmoil in August, CLO issuance is poised to pick up again as the loan market stabilizes, sources said. Indeed, the pipeline has even continued to grow despite the fact that a number of deals stalled over the summer.
Estimates vary, but there looks to be roughly 10 CLOs in various stages of development in the pipeline, and most sources estimate that six to eight of those will get done before the end of the year. With deals averaging roughly $400 million, that would add another $2.4 billion to $3.2 billion to this year’s total U.S. volume.
Given we’ve already seen in the neighborhood of $10 billion of issuance (again, depending on who you ask), the final number should fall comfortably in the $10 billion to $15 billion range that analysts predicted earlier in the year.
“We actually have a strong pipeline that we’re looking at now,” said Yvonne Fu, a managing director at Moody’s Investors Service. “It’s always hard to make projections as to whether deals will get done or not, but just based on past experience, we know that by the time things reach a ratings agency they’re pretty serious.”
This includes deals that were marketed earlier in the summer then delayed because of the market volatility that hit its peak in August, as well as new entries. “The pipeline certainly didn’t stop growing,” Fu said.
One in the former category, the $407 million Atrium VII CLO to be managed by Credit Suisse Asset Management, printed Wednesday after launching in June. Credit Suisse, along with GreensLedge Capital Markets and Mitsubishi UFJ Securities, priced the transaction, which includes a $253 million triple-A tranche priced at Libor plus 155 bps, as well as $41.6 million in equity.
Pricing on this latest deal shows a widening that took place late in the summer, as the CLOs priced prior to September contained triple-A tranches at Libor plus 125 basis points.
Another older deal that looks close to pricing is the $400 million Ares XXIII CLO, to be managed by Ares Management. Goldman Sachs is the bank on the transaction.
Other CLO managers with deals in the pipeline include Sankaty Advisors, Symphony Asset Management, American Money Management Corp. (AMMC), Prudential Fixed Income, Frasier Sullivan, Octagon Credit Investors and Lyon Capital Management and Invesco. Of note, both AMMC and Prudential have returned to the market after being absent since late 2007 and mid-2008, respectively.
To be sure, there’s no lack of interest in selling and managing CLOs, sources said.
“The pipeline of people who can potentially get a deal done might be six to 12; the pipeline of people who wish they could get a deal done is infinite,” quipped one CLO manager.
Placing the equity tranche — a.k.a. the riskiest loans — of a CLO is always one challenging aspect of completing a transaction, but according to some sources, the demand for equity has actually improved in recent months. This is a good sign for managers who don’t have the capacity or the inclination to hold equity on their books.
“Compared with the deals done in 2010, this year we are seeing a more diversified pool of equity investors participating in CLOs,” said John Popp, head of the leveraged investments group at CSAM. “This includes new as well as more traditional investors in the space. Certainly some CLO managers have had affiliates speaking for some or all of the equity tranche, and that can accelerate time to market, but it’s no guarantee.”
The reason for the increase in demand appears to be simple performance.
“Equity tranches continue to outperform,” said Taryn Leonard, a managing director in the structured credit group at Babson Capital. “The macro uncertainties actually benefit equity tranches because [interest] rates are likely to stay low longer. In the current low rate environment, the benefit of Libor floors on the underlying loans flows to the equity. So well performing equity is paying high quarterly distributions often in the context of eight to 10 percent. If rates stay low, these outsized distributions will continue for a longer period of time.”
Likewise, in an Oct. 20 report, Citigroup analysts wrote that while CLO liability spreads have widened quite dramatically, from a weighted average spread of 190 bps in mid-July to an estimated 270 bps as of early October, over the same period, loan spreads widened by roughly 150 basis points, suggesting that the arbitrage might work, even with equity investors requiring higher than the low-mid teens returns that were acceptable earlier in the year.
But despite expectations that the year will end on a somewhat positive note, market watchers have not thrown caution to the wind.
Rishad Ahluwalia, an analyst at JPMorgan Securities, said the bank has lowered its projection for 2012 global CLO volume to a range of $15 billion to $20 billion from a range of $20 billion to $30 billion. And for that outlook to improve again, the macro environment would have to look up.
“Most directly you need to have stability in primary pricing, which would lead from stability in secondary pricing. We have had some recently, where triple-As have stopped widening,” Ahluwalia said. “And, obviously, you need to have more progress made in Europe. If things improve a little on the macro front, that’s the biggest driver. It’s very non-CLO specific; it’s much more about the broader markets.”
