Recent leveraged loan spread widening could be a boon to new-issue CLO investors - as long as the widening is in fact due to market technicals. Bear Stearns analysts said as much last week, pointing out that widening in leveraged loan spreads could be owed mainly to supply and demand mismatches. On the fringes, some of the pull-back among certain investors could be due to loosened loan covenants, analysts said. But credit fundamentals within the U.S. loan market are widely anticipated to remain strong for several years - opening the door for equity investors to take ample opportunity of the record high return-on-equity in the space.
As projected CLO equity returns continue to rise, the deals show "value at the wings," JPMorgan Securities analysts wrote last week. They said CLO spreads appear to be standing their ground, although double-A and triple-B tranches could be weakening. Estimated U.S. CLO return on equity was at 16% as of last week - a two-year high, JPMorgan said. "Given [the] lack of significant widening in HEL ABS spreads, CLO equity now offers higher returns than modeled SF CDO returns ... which is attractive given fundamental credit trends," analysts stated, adding that mezzanine structured finance equity is producing an ROE in the low to midteens. Analysts expect warehousing CLOs, which represent a U.S. arbitrage pipeline of about $12.7 billion, and excess cash in existing CLOs will support loan spreads. "With CLO debt spreads near tights and HY defaults expected to remain low in the near future, CLO equity presents an increasingly attractive risk-reward outlook," they wrote.