With the macroeconomic backdrop brightening, the CLO market regained its footing in the first quarter. Managers printed 15 new deals totaling $5.83 billion, which is the strongest quarter for the new-issue CLO market since the first quarter of 2008, when issuance totaled $6.02 billion.

While still paltry when compared to the $24-billion-a-quarter average of 2006, the figure is large by recent standards. In terms of number of deals, the first quarter’s 15 deals top the 10 deals priced in the fourth quarter of 2010 and the three printed during the same period last year.

The revival of the CLO market did not come in a vacuum. A few factors helped the market get back on its feet after a rocky second half of 2011.

To start, the brightening U.S economic outlook lifted spirits on the Street, while at the same time, there were no major shocks from the eurozone or elsewhere to derail the recovery experienced during the quarter. As was the case in the first half of 2011, another positive was the fact that the default forecast for loans remains benign.

Also key to the market’s revival was growth in the CLO investor base during the quarter. That said, market participants caution that though the base of investors is larger than it was six months ago, it is still not deep.

Finally, as yields narrowed across the credit markets, spreads in the secondary CLO contracted, from AAA all the way down the stack. That helped drive new-issue spreads tighter, facilitating new issuance against the backdrop of a leveraged loan market that saw secondary and new-issue yields tighten considerably during the quarter.

On the first regular-way deal to print in the first quarter – Symphony Asset Management’s $388.5 million vehicle – the AAAs printed at a discounted margin of L+155. By comparison, the AAA tranche of PineBridge Investments’ $412.5 million print – the second-to-last deal to print in the quarter – came at a DM of L+140.

So far in the second quarter, the CLO market has seen new-issue spreads tighten even further: GoldenTree Asset Management yesterday priced at $526.8 million deal, with the AAAs printing at a DM of L+130, while Symphony Asset Management is also marketing a deal with a triple-A tranche talked in the L+130 area, sources say.

Given the sharp contraction in collateral spreads over the same period, however, liabilities had to tighten in order for the arbitrage to make sense for investors. As of March 30, the yield implied by the average bid of the S&P/LSTA Leveraged Loan 100 Index had narrowed to 5.76%, from 6.32% at the end of December.

In the near term, there is optimism that the April 1 start of the Japanese fiscal year could bring in more investors, allowing liability spreads to contract even further. Still, market participants don’t expect to see a dramatic shift.

Assuming collateral spreads don’t narrow as well, that could generate enough arbitrage to attract open-market equity, thereby allowing a broader range of managers to play. Equity returns, sources say, are in the range of 10-15%.

While the investor base grew during the quarter, sources say there is more progress to be made. One encouraging sign in this regard is the fact that at least three of 2012’s CLO prints are greenfield vehicles that reportedly funded with equity that was largely syndicated: Credit-Suisse Asset Management, ING Investment Management, and Octagon Credit Investors. More such deals are on the bulging second-quarter calendar.

There’s also optimism that the window will open for managers that haven’t printed a deal since the heyday of 2006-2007. The first quarter saw a lot of familiar faces: only four of the managers of the quarter’s 15 deals didn’t print a deal in 2011.

Guarded optimism 
Assuming CLO issuance continues at the same clip throughout the year, issuance would reach about $23.32 billion.

Some market participants believe that figure is in the ballpark of what is on tap for 2012, barring any major disruptions from the eurozone or elsewhere. Sources note that the secondary CLO market is typically slower to recover from an exogenous shock than the secondary loan market, and thus it takes longer for the CLO engine to rev back up relative to the new-issue leveraged loan market.

That caveat aside, many market participants expect issuance to top the $12.3 billion printed in 2011. Based the first-quarter total and the 12-15 deals in the pipeline in various stages of origination and marketing, Sajid Zaidi, head of CLO structuring at Morgan Stanley, said at last week’s Information Management Network’s CLO and Leveraged Loan Conference that “if issuance continues at its current clip, I think I feel pretty comfortable [issuance] will end up between $20-25 billion for 2012.”

Others, however, question whether this level of issuance can continue. “We feel that this rate of issuance in the primary market is unsustainable with uncertainty still surrounding Europe’s outcome and global growth concerns,” said RBS CLO strategist Justin Pauley in a recent report. “Another deterrent to primary market growth may be the proposed rules and regulations such as new risk-retention rules. We continue to expect $12-14 billion of total issuance in 2012, excluding refinancings.”

In the report, Pauley notes that the first quarter of 2012 looked a lot like the start of 2011 “when the markets were trending upward and new issue triple-A’s were pricing close to 120 bps.” That said, in light of the strong first quarter, he noted in a recent interview that “we remain cautiously optimistic.” – Kerry Kantin