Two thousand eighteen may not be another record year for the U.S. CLO market after all.
Wells Fargo, which had one of the highest projections for new issuance of collateralized loan obligations this year, at $150 billion, has now trimmed its forecast by $20 billion to $130 billion. (The figures exclude refinancings.) That puts it more in line with other investment banks, including Deutsche Bank and J.P. Morgan.
The former mark would still shatter the post-crisis record issuance of $124.1 billion in 2014, but just barely. Last year's tally of just over $118 billion was the second busiest year since the "CLO 2.0" market emerged in 2011.
“While the CLO primary market is still active...volume is lower when compared to prior months,” wrote David Preston, Wells' head of CLO and commercial ABS research, in report published Monday. “In addition, loan net issuance is down,” curbing the potential supply to maintain the $11.9 billion monthly average of new CLOs for the trailing six-month average as of last Friday.
September’s new issuance volume was $8.5 billion, while $5.5 billion in CLOs have priced for the month through Oct. 19.
Preston noted the slowdown comes despite the CLO and loan market’s immunity from the volatility this month in the equity and high-yield bond space – as well as some relief from widening spreads on CLO tranches.
In the last month, spreads on some lower-rated mezzanine tranches (rated double B or and triple B) have tightened while AAA spreads – the primary factor in determining a CLO’s total financing costs – remained flat after five consecutive months of widening to 116.7 basis points from a March average of 98.1 basis points.
Wells attributed the tighter spreads to managers pulling back on the market, leading to a “relative” lack of supply for investors expecting high volume numbers in September. “It appears repeated summertime fears of heavy post-Labor Day CLO issuance may have spooked some issuers,” the report states.
Wells’ lower forecast meets with the range set by other banks and ratings agencies surveying the CLO market.
Morgan Stanley has projected $110 billion since February, when surprisingly brisk activity in January prompted many banks, including Wells, to revise their projections upward.
Deutsche Bank has a $130 billion year-end projection of gross new-deal volume that the market appeared on course to “meet and possibly exceed,” the bank’s securitization research team stated in a September report.
“Risk retention repeal, increased foreign investor appetite, rising Libor, and a higher spread pickup to [investment-grade] corporate risk have helped increase supply and investor demand,” the Deutsche report stated.
S&P Global Ratings expects the final 2018 market volume to tally $130 billion, a total it revised earlier this year from its early call for $110 billion in new deals.
JPMorgan on Monday maintained its $115 billion to $130 billion range in a report updating its market forecast first published last December and affirmed in June. According to the new credit research report, believes “supply will cool off in the coming weeks, which has already started to happen.”
The report stated that “if demand remains constant and supply slows down (which we think both will), the tide will turn and spreads move in to tighter levels providing some relief to the arb,” or the cost difference in financing loan acquisitions and coupons paid to investors.
Despite the potential slowdown, JPMorgan sees the CLO market maintaining its 2018 momentum into next year. The report on Monday released JPMorgan’s early 2019 market forecast of $135 billion in new-deal issuance, stoked by investor demand, four projected Fed rate hikes (which benefit floating-rate instruments like CLO securities) and a wide field of managers to sponsor deals.
About 144 active managers are in the space, with 102 printing BSL CLO deals in 2018, JPMorgan noted.
Another factor in favor of strong 2019 issuance is an expected high volume of leveraged-loan activity. Refinancing accounted for much of the $482 billion in leveraged loan issuance volume in the first half of 2018 ($315 billion), but acquisitions and leveraged buyouts fueled 77% of a declining loan volume (over $102 billion) in the third quarter, according to Thomson Reuters.
Merger & acquisition activity has totaled $210 billion year-to-date, and is set to exceed last year’s decade-high level of $213 billion, JPMorgan’s report stated. Leveraged buyout volume totaling $109 billion through Oct. 19 and $98 billion in 2017 “is also a high since 2007’s $156 [billion],” noted JPMorgan.
