CLO Sales Surge Tempers Rally as Borrowers Double Back for More

Collateralized loan obligation sales have rebounded so strongly that the heavy supply is crimping a rally in the sector even while investors seek to rotate into floating-rate notes as Treasury yields march higher.

Several CLO managers have issued at least two new deals in only three months, a highly unusual phenomenon for a first quarter. Sales have risen following a difficult 2020 as issuers seek to tap higher demand to offload the securities cheaply and cut costs on existing deals through refinancing and so-called reset transactions.

“Cheap CLO funding costs and a postponed CLO supply calendar from the pandemic led to the busiest CLO issuance quarter on record in the first quarter of 2021,” Citigroup Inc. analysts led by Maggie Wang said in a Wednesday research note. “We see execution risk and spread widening ahead.”

Premiums widened this week after almost hitting a post-crisis tight of just under 100 basis points above the London interbank offered rate in mid-March as investors work to absorb the gush of new bonds. Spreads on AAA tranches may widen to 115 basis points over Libor by the end of the second quarter, the Citigroup analysts said.

CLO Sales Surge Tempers Rally as Borrowers Double Back for More

At least 15 issuers from Credit Suisse Asset Management and KKR to MJX Asset Management have tapped the market twice in 2021 to sell new debt, according to data compiled by Bloomberg. Two other issuers, Carlyle and Palmer Square Capital Management, have even sold new CLOs on three occasions.

That pace exceeds even the most prolific year for the sector. In 2018 -- when the CLO market hit its all-time annual record of more than $130 billion -- each of the aforementioned managers minted an average of only three deals for the entire year, the data show.

Crowd of Issuers

About 64 managers have accessed the market so far this year with a new broadly-syndicated loan (BSL) or middle-market CLO, according to data compiled by Bloomberg. That’s already more than half of the roughly 111 firms that issued those deals in all of 2019, the year with the highest number of individual issuers launching transactions.

As of Wednesday, there were $36.2 billion BSL and middle-market new-issue CLOs sold this year, a 138% increase over the same period last year. The market was stymied immediately following the lockdown a year ago but had a strong comeback by the end of 2020 as there were fewer loan defaults than expected and optimism spread with news of the vaccines.

Primary mezzanine spreads have already seen pressure from recent supply and will likely widen ahead of the AAAs. The widening “should result in more spread dispersion and manager tiering in the second quarter of 2021,” Citigroup said.

Refinancings, Resets

The eye-popping sales totals climb even higher when adding refinancings and resets of older CLOs. Volume of those deals is likely notch a fresh record this year.

Bank of America Corp. estimates that combined resets and refinancings could reach as high as $250 billion in 2021. About $62 billion in CLO refinancings and resets have been sold this year as of March 24, compared to about $24.6 billion and $7.2 billion for the same period in 2020 and 2019, respectively, data compiled by Bloomberg show.

“Spreads on CLO AAA liabilities tightened to levels we haven’t seen in years, and therefore older deals are super-ripe for refinancing,” said Nick Robinson, a partner at Allen & Overy, which represents CLO issuers. “It’s absolutely crazy how busy the market has been. But the incredible pace of issuance we’ve seen, especially, across resets and refis, may just not be sustainable.”

Relative Value: CLOs

  • Citigroup continues to favor CLO BBB tranches over high yield and leveraged loans
  • Secondary CLO BBB offers similar yield to high yield BB and BB loans (3.7%). However, CLO BBB offers a 60 basis point spread pickup to high yield and loans, and better price convexity
  • Secondary CLO BBs continue to offer higher-than-average spread pickup to loans and high yield bonds, the analysts said

Quotable

“Despite its idiosyncrasies, we are most bullish on CMBS to pick up beta,” said Dave Goodson, head of securitized credit at Voya Investment Management. “Coming out of the pandemic, we are willing to give the sector the benefit of the doubt and take some risk. There will be winners and losers, but we have a good feeling on some hotel and retail properties that might provide some spread premium. We do remain cautious on office properties.”

What’s Next

Credibly is premarketing a small business loan ABS for next week. Issuers that have filed ABS-15Gs for upcoming deals include PFS, Automotive Credit Corporation, and Harvest SBA Loan Trust.

©2021 Bloomberg L.P.

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