CLO Resurgence Extends Into February as a Dozen Deals Line Up

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Collateralized loan obligation managers are expected to extend a run of frenzied sales this month as they continue to cut deals at sweetened terms.

No less than seven new-issue CLOs are currently marketing following one of the strongest Januarys in years. There are also two refinancings and at least four so-called resets of older deals on offer.

The rise in sales comes as risk premiums for new transactions, which package and sell leveraged loans into tranches of varying risk and potential return, have tightened to pre-pandemic levels. That’s prompted managers to bring new deals at favorable terms and refinance and reset existing bonds at cheaper costs, marking a stark turnaround in a sector with heavy exposure to company bankruptcies caused by the lockdowns.

Issuers that may price deals next week include Oak Hill Advisors, Wellfleet Credit Partners, Credit Suisse Asset Management, CVC Credit Partners, Trimaran Advisors and Kayne Anderson Capital Advisors, according to data compiled by Bloomberg News.

“The waves of downgrades that the market feared at the beginning of the pandemic -- both on the underlying leveraged loans and the CLO bonds themselves -- didn’t seem to materialize, and it shows the resilience of the market,” Larry Berkovich, a partner at Allen & Overy who represents CLO managers, said in an interview.

January new-issue volume was nearly $9 billion, the highest for the month in data going back to at least 2013 when $8 billion was issued, according to Leveraged Commentary & Data, a unit of S&P Global Market Intelligence. In recent years, 2018 came the closest, with a January haul of $6.3 billion, according to data compiled by Bloomberg.

Average AAA spreads for top-tier CLO issuers are in the range of 120 basis points over Libor, or tighter, compared to 180 basis points last May and higher in March at the start of the pandemic. Average senior-note spreads for top-tier issuers were roughly 120 to 130 basis points over one year ago, prior to Covid, according to data compiled by Bloomberg.

Falling funding costs for CLOs have improved the arbitrage, and pushed many issuers to refinance and reset.

Resurrection

CLOs were besieged last year by an unprecedented wave of leveraged-loan downgrades, causing them to exceed allowable limits of CCC rated loans and breach critical coverage tests in the bonds. This temporarily turned off cash flows to equity investors, or first loss bondholders, in some securities. It also led to a swath of ratings downgrades on the CLOs themselves in the first few months of the pandemic, and pressured CLO managers to trade out of distressed credits.

New sales shut down for nearly a month last March as the Covid-19 crisis rocked financial markets. But transactions started emerging again in mid- to late-April, and issuance started rebounding strongly in October.

CLO firms “did a good job managing around the distressed assets to preserve cash flow to the equity” tranche, said Berkovich. “Moody’s also adjusted its criteria recently to give more flexibility and take the realities of the current market into account.”

The market has been buoyed by support from the Federal Reserve to the riskiest companies -- those that issue leveraged loans -- as well as smart trading of CLO loan portfolios to trade out of risky credits, protections built into the deals, and a lower number of loan defaults than anticipated.

By November, fewer loans than expected defaulted and downgrades of both loans and the CLO bonds ebbed, while some are even being upgraded. News of effective vaccines has only added to the optimism. Moody’s Investors Service put 188 CLO bonds from 114 U.S. transactions on review for possible upgrade.

In addition, refinancings and resets of existing CLOs may notch a fresh record this year as risk premiums narrow, allowing portfolio managers to lock in better terms. More than 30 refinancings, resets, and reissues were priced in January, according to data compiled by Bloomberg.

Relative Value: CMBS

  • Voya Investment Management sees good relative-value opportunity in CMBS conduits, since spread tightening on those bonds lagged other fixed income sectors the most coming into the year and have more room to tighten than single-asset, single-borrower (SASB) transactions, Dave Goodson, head of securitized credit at the firm, said in an interview
  • Commercial real estate CLOs also represent a good opportunity and have a place in Voya’s portfolio, but investors need to trust all the parties involved because active management in that particular product can create risk, Goodson said
  • Voya is bearish on CMBS deals with call options, as they can cap price upside and force holders to be sellers sooner than expected. These options are a small but meaningful part of the CMBS universe, Goodson said, focused in floating-rate and SASB deals
  • “Call execution is likely to prove efficient, to investors’ chagrin. Said differently, the credit convexity -- compared to deals without these call options -- is poor,” Goodson said. “Well-performing deals can get bought back from us at a lower price than they’re otherwise worth from a credit risk perspective”

Quotable

“We are the most bullish right now on CMBS,” Voya’s Goodson noted. “It offered the most spread premium coming into the year and should be impacted in a good fundamental way by all the stimulus in the market and economy.”

What’s Next

ABS deals in the queue for next week include Credit Acceptance (subprime auto), Harley Davidson (prime motorcycle loan), BMW Canada (auto lease), Regional Management (consumer installment loans), Santander Consumer (subprime auto), Sunnova (solar loan), College Avenue (private student loans), Navient (FFELP student loans), IPFS (insurance premium finance), and Affirm (point-of-sale consumer loans).

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