CLO Credit Lines Grow Fast With Annual Sales Record Looming
(Bloomberg) -- Banks are giving more credit lines to firms putting together collateralized loan obligations, signaling that the intense pace of sales for the securities is only getting hotter.
There may be as many as 200 active lines of credit financing CLOs now, known as warehouse lines, a 30% increase since July, estimates Ryan Kohan, head of leveraged loans at Western Asset Management. These figures are at or above 2018 levels when the CLO market saw record annual issuance, he said.
“The number of warehouses means banks feel comfortable that they can print deals in this favorable environment,” Kohan added.
U.S. new-issue CLO issuance is on track for a record year in 2021, currently standing at around more than $113 billion. Sales broke the $100 billion mark at the fastest pace on record, according to data compiled by Bloomberg. Moreover, August posted an official all-time monthly high for CLO offerings, with $19.6 billion sold, according to data compiled by Bloomberg News and Bank of America Corp. strategists that looks at broadly syndicated loans and middle-market new issue deals. The global CLO market has crossed the $1 trillion mark in outstandings.
Among the factors making for a favorable environment for CLO issuance is investors’ thirst for yield and for floating-rate paper, and a strong supply of new leveraged loans planned for the next few months. The potential profit for putting together CLOs is also relatively high, as measured by the gap between the interest earned from the underlying leveraged loans and the cost of borrowing for a CLO manager to purchase the assets, known as the arbitrage. That makes it easier to attract CLO equity capital to sponsor new deals.
Moreover, there has been “huge demand for paper” from banks, Kohan said, as they have had record deposits and need yield. Banks are especially interested in the investment-grade part of the CLO structure, which may yield more than similarly rated high-grade corporate bonds.
The brisk issuance pace is set to continue, with CLOs from Bain Capital Credit, Arrowmark Colorado Holdings, and Oaktree Capital Management already making the rounds in September. More than $2 billion is fully priced for the month so far, according to data compiled by Bloomberg.
Another positive: CLOs survived last year’s economic downturn quite well, and are structured with various safeguards and enhancements to protect investors.
“So far, only a modest number of U.S. CLO tranches are expected to default coming out of the 2020 economic downturn, mostly limited to the junior-most tranches within the capital structure of the CLO,” S&P Global Ratings analysts said in a study released last month.
Out of more than 1,300 U.S. CLO transactions rated by S&P from 2010 through the second half of 2021 -- or nearly 11,000 tranches across the rating spectrum -- only two tranches had defaulted as of mid-August. Those slices were originally rated junk, with grades of BB and B.
“You can pick and choose your spots in senior tranches of CLOs and not have too much concern about fundamentals,” Jake Remley, a senior portfolio manager at Income Research + Management, said in an interview. “The enhancements are quite high. Moreover, as long as a particular manager’s track record weathered a couple of these credit cycles, including 2008, then it shows they have the ability to maneuver through a difficult environment.”
Of course there are always risks. Some potential factors that can get in the way of this year’s strong issuance include investor indigestion -- a glut of supply may cause buyers to back off, which can soften spreads -- or a change in the macro economic environment, such as slower growth than expected, Western Asset’s Kohan said.
Relative Value: CLOs
- Western Asset Management particularly likes the mezzanine part of the CLO capital structure, according to Kohan. There’s an expectation of low default rates and limited credit risk, so mezzanine tranches are an attractive place to pick up incremental yield
- CLO equity is very attractive now too, with mid- to high-teen returns, and unlike private equity, you don’t have to wait five years to see the realization of IRRs
“The days of ABS being synonymous with liquid, high-quality credit cards and auto trusts are long gone,” said Income Research + Management’s Remley. “Growth in ‘Other ABS’— ABS backed by collateral other than auto, student loan, equipment, or credit card receivables — is exciting for relative value hunters in the sector. New collateral types include franchise royalty receivables, triple-net lease obligations, and pools of specialty warehouse and data center leases. Other ABS types – railcar, timeshare, and cell towers – are expanding their market footprint. Year-to-date, these other types of ABS have topped 25% of total ABS issuance, outpacing all other traditional ABS sectors combined (save auto ABS at 50% of issuance).
“It’s no wonder ‘other ABS’ has grown. Deals backed by new collateral types often require attractive pricing concessions to attract buyers.”
ABS deals in the queue for coming weeks include Global Lending Services (subprime auto), GM Financial (debut revolving prime auto), CommonBond (private student loan ABS), CarMax (prime auto), Tesla (prime auto), Santander Consumer (prime auto lease), Pagaya (consumer loan), Bankers Healthcare Group (commercial/consumer ABS), and Hyundai (prime auto lease).
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