Amid strong credit-market conditions and falling senior liabilities, CLO activity is on the rise.
Indeed, managers have printed or announced $2.2 billion of new CLOs this month. That puts February on pace to become the busiest month for CLO production since the credit crisis, topping November 2011, when $2.5 billion of new vehicles cleared (or $1.5 billion excluding Guggenheim’s atypical $1 billion deal).
All told, managers have inked or launched $3.3 billion of new CLOs this year as of Feb. 16. That compares to $4.4 billion of prints during the fourth quarter, which also is the most since 2007. Of course, these figures pale beside those from the salad days of the mid-2000s.
The recent mini-surge in CLO volume is part and parcel of the broader positive bias in the credit markets that has driven funding costs lower. Consider AAA liability spreads. Deals in 2012 have cleared at discounted margins of L+148-150, down from L+155-170 in the fourth quarter (see the attached spreadsheet for details), but still wide of the L+120-125 at which senior liabilities printed during the second quarter of 2011, when the market was running hot.
Down the stack, too, spreads have tightened. Indeed, the weighted average discounted margin on 2012 deals for which data are available – excluding Golub’s middle-market-oriented vehicle – was L+248. That is down from L+268 in the fourth quarter, but it is far above the recent low of L+189, from the second quarter.
In the near term, managers expect CLO issuance will continue at $1-2 billion a month, assuming the markets hold together and there are no outside shocks. What’s more, like they did last year, liability costs could ratchet lower when the Japanese fiscal year begins on April 1.
Still, players say the ongoing drought in collateral creation will weigh on issuance. In the year to date, new-issue institutional loan volume has barely kept pace with repayments. As a result, the stock of S&P/LSTA Index loans outstanding expanded 0.5%, or $2.6 billion, to $519 billion on Feb. 10, from $517 billion at year-end. In response, collateral spreads have narrowed more profoundly in recent months than have liability spreads.
Given these trends, managers say prospective equity returns for new regular-way CLOs are modest, at 10-14%. That level has limited appeal on the open market, managers add, especially since structured finance remains a suspect asset class among many institutional investors.
CLO activity, thus far at least, has remained concentrated among large platforms – public company managers, BDCs and private-equity affiliates – that can bring the equity either through an affiliate or relationship buyers. However, some managers that don’t fit the mold are said to be in the process of raising new deals.
Though the data are not public for all deals, sources say managers lined up all of the equity for at least two 2012 CLOs – Apollo and Onex – while AMMC will take 51% of the deal it currently has in market.
Managers say two conditions are necessary for the market to break out to higher levels of issuance: (1) muscular demand for credit product must persist and continue to drive CLO funding costs lower, and (2) new-issue loan volume must become more bountiful, providing fodder to ramp deals and allowing collateral yields to widen.
Given these variables, no one is predicting that CLO issuance will increase significantly in the foreseeable future. After all, the M&A loan calendar remains light, and most new loan flow is concentrated in opportunistic trades that add little to overall supply.
Another brake on volume is the fact that warehousing lines remain unattractive to most players. Though players say that more dealers are offering such lines, providers require investors to take first-loss positions of 10-15%. That is a high hurdle for most investors, especially in light of today’s low-wattage new-issue market.
In the final analysis, then, market players find the recent pop in CLO activity encouraging. But they are not ready to call the turn. Therefore, Street analysts are holding their CLO forecasts to year-end levels of $12-25 billion, with David Preston of Wells Fargo putting the figure at $12 billion; Justin Pauley of Royal Bank of Scotland forecasting $12-14 billion; Rishad Ahluwalia of JPMorgan estimating $15-20 billion; and Vishwanath Tirupattur of Morgan Stanley estimating $15-25 billion. – Steve Miller