Spreads on collateralized loan obligations appear to have stabilized in the secondary market after widening in June, according to Wells Fargo.
“For the most part, the CLO secondary market has found its footing,” analyst David Preston wrote in a report published today. He said that spreads were largely unchanged this week, as they were during the previous week, which was shortened because of Independence Day.
“It may be that the holiday week provided a welcome respite to the sell-off, allowing investors to catch their breath, assess the damage and evaluate the risks,” Preston said.
Spreads on triple-A tranches of U.S. CLOs issued post-financial crisis with a weighted average life of 5-6 years are now trading at 130 basis points, 10 points wider than they were a month ago, according to the report. The spread widening has been more pronounced further down the capital stack, with double-As out 20 basis points at 205 basis points, single-A spreads out 50 basis points at 345 basis points, triple-B spreads out 40 basis points at 465 basis points, and double-B spreads out 75 basis points at 675 basis points.
Some of this spread tightening could be reversed soon. Since late June, credit spreads in more liquid markets have tightened, and key U.S. stock market indices have rallied; Preston said these indicators usually point to CLO spreads tightening in the near future, especially at the BB and BBB levels.
Another factor that agues for spread tightening in the secondary market, according to Preston, is that there has been little new issuance so far this month.
At $7.2 billion, June issuance was actually higher than in February, before volume picked up ahead of new deposit insurance rule that make CLOs less attractive assets for banks. However, Preston noted that 65% of June issuance occurred in the first half of the month before volatility swept across risk assets as the S&P 500 fell almost 5% in one week.
There has been little new issuance so far in July.
“CLO primary activity is still muted, as many large AAA investors are apparently on temporary hiatus,” he said. “We believe many investors are still awaiting clarity on true market clearing levels as well as regulatory and internal accounting procedures related to the FDIC changes.”
In the meantime, Preston said, issuance could be quite “lumpy.”
He said this volatility should result in better returns for primary equity buyers when the market does return, as managers may have been able to utilize warehouse facilities to purchase loans at more attractive prices.
