Risk retention repeal, a “strong appetite” for CLO equity purchases and ripe market conditions for refinancings are prompting Wells Fargo to bump up its forecast of collateralized loan issuance in 2018.
In a fixed-income research report issued Friday, structured products analyst David Preston said the bank’s research department has raised its 2018 estimate on broadly syndicated CLO primary issuance to $150 billion, from the initial $125 billion forecast published last December.
Although that initial number included expected capital raising for risk retention stakes, Wells’ revised forecast takes into account the continued heated demand for floating-rate assets, plus an expected surge of issuance of new managers debuting or returning to the market in the wake of a federal court's repeal of rules requiring managers to maintain skin in the game of the deals they sponsor.
Reset and refinancing volume is also expected to remain brisk.
“Assuming range-bound spreads and a benign credit environment," Preston wrote, "we expect the pace of CLO supply to continue" through" the second half, “as newer or smaller managers look to issue new deals, and as managers look to reset existing deals nearing the end of reinvestment.”
Morgan Stanley had previously revised its 2018 full-year CLO forecast to $110 billion from $100 billion in February, although that was in the wake of a federal court decision repealing risk retention rules on CLOs requiring managers to maintain a 5% holding of the deals they issued.
Thomson Reuters LPC numbers show the U.S. CLO market has already set a record first-quarter pace of $31.7 billion in new issuance. Through mid-May, according to Wells, $50 billion of new-issue deals have been issued year to date, along with $42 billion resets and $13 billion in refinancings.
Wells is maintaining a $140 billion refi/reset activity forecast, compared with $165 billion in full-year 2017.
Wells also projects a higher-than-expected market volume in European CLOs of €25 billion of new-issue deals and €18-20 billion in refinancings and resets, based on year-to-date activity of €9 billion and €8 billion, respectively.
Wells' report also delved into the surprising 2018 rise of mezzanine CLO paper as an attractive investment target over the more senior AAA notes in deals.
Since the end of 2017, AA-rated tranches have emerged as the more attractive offering for investors, after market trends expanded the rate difference paid between AA and AAA tranches to more than 60 basis points (compared with 25 basis points last December). The spread ratio (1.54x) of the two tranches to their highest level in more than two years, according to Preston.
The declaration of AAs as the “best value” in CLO estimates contrasts the view six months ago, when Wells recommended investors “paying up” for higher-quality bonds with limited upside in buying the lower-rated tranches in new-issue CLOs.
The report stated triple B-rated tranches also "look more attractive today than in Q4 2017, or even in earlier 2018," with the spread ratio against AAA notes "roughly in line with the post-2012 average (2.9x), after moving below 2.2x in Q4 2017."
Global CLO AA paper is also considered Morgan Stanley’s “favorite part” of the capital stack, according to a global securitized midyear products outlook report it published Monday.
But several factors point to a widening environment for AAA paper the rest of the year, the report stated, which could swing the value pendulum back to the senior notes: a flatting U.S. Treasury yield curve, weakened U.S. corporate credit performance and the rising costs of foreign-exchange hedging for international investors buying U.S.-dollar bonds tied to rising Libor costs.