CLO, Securitized-Debt Sales Are On Fire as Investors Hunt For Yield

Demand is booming this year for securitized debt, as sales have not only recovered following last year’s Covid-induced dip, but are even eclipsing the pace of previous strong years.

Sales of new CLOs, for example, are up an astounding 152% compared to the same time last year, and that’s not even including what some are projecting to be an all-time record issuance year for refinancing and resets of older deals, according to data compiled by Bloomberg. The pace of unrelenting business has been so mind-boggling that deal participants such as lawyers have regularly been pulling all-nighters to get transactions out the door.

Even investment banks, who are typically hungry for fees, have had to turn away business due to the onslaught of CLOs during the first quarter, according to market observers.

“The CLO market has been so busy that many banks, law firms, and rating agencies are overwhelmed,” Ronnie Jaber, portfolio manager and head of structured credit at Onex Credit Partners, a CLO issuer and investor, said in an interview. “The issuance queue is like a ride at Disney World. Some rating agencies have said they may not have a slot to rate a new deal for some managers until late summer.”

The record levels of CLO issuance in the first quarter were driven by refinancing and reset volume, which saw just over $85 billion of these deals alone as of April 22, according to data compiled by Bloomberg. This surpasses the $24.6 billion seen during the same period last year, $10.2 billion for the same period in 2019, and about $39 billion for 2018.

Refinancing drew interest because the spreads on new CLO AAA liabilities narrowed to near post-crisis tights in the first quarter, making older deals ripe for repricing so that issuers can lock in better terms. By the end of March the heavy supply caused some investor fatigue, and spreads widened slightly, which most investors consider to be a technical blip rather than a fundamental issue with CLOs. Issuance will likely pick up again and spreads will resume their tightening.

“The deals that were issued in 2020 -- which had high debt costs -- are starting to exit their non-call period, so we expect those transactions to be reset or refinanced and, combined with attractive new-issue spreads, activity should remain high,” said Onex’s Jaber.

Meanwhile, fresh CLO formation so far this year, including those backed by broadly syndicated leveraged loans as well as those backed by middle-market loans, is at $44.9 billion, compared to $17.6 billion for the same period last year and $39.6 billion in 2019. The pace is even eclipsing 2018, when the CLO market hit its all-time annual record of more than $130 billion.

Relative Value

Securitized credit generally lagged the recovery in corporates last year and therefore still offers some incremental yield to investors struggling to find returns in a tight credit market. Moreover, many of the sectors, such as CLOs, and some student-loan ABS, are floating-rate, which is alluring during a time when rates are projected to increase.

Sales of asset-backed securities are more than 45% ahead of the total seen at the same time last year, and the pace of issuance is the fastest in at least four years. Year-to-date ABS sales are at about $85 billion, compared to $59 billion for the same period last year and $83 billion for that time frame in 2019, according to Bloomberg data.

Structured securities have built-in safeguards and can still offer some relative value compared to corporates: For example, a BBB rated slice of a subprime-auto ABS with riskier-than-normal collateral from first time issuer Credito Real priced this week with close to a 3% yield. In CMBS, a AAA rated tranche of a recent deal backed by loans on two high-quality New York City office towers paid investors more than 2.6%, the type of yield which would be hard to come by even in lower-rated corporate bonds.

A slew of ABS deals are lined up for next week, including one backed by agriculture equipment loans from De Lage Landen, another equipment ABS from MassMutual, and two deals backed by small business loans from Harvest and online lender OnDeck.

The CLO market, meanwhile, has been buoyed by higher demand for floating-rate debt as many market participants expect rates to continue rising, making fixed-rate bonds less attractive. Last year the market was helped by support from the Federal Reserve to the riskiest companies -- those that issue leveraged loans -- as well as portfolio managers trading out of perilous credits, protections built into the deals and a lower number of loan defaults than anticipated.

The spread tightening this year has been key in improving the so-called arbitrage -- the gap between the interest earned from the underlying leveraged loans and the cost of borrowing to purchase the assets. A healthier arbitrage enhances the economics of the transactions, which makes it easier to attract CLO equity capital to sponsor new deals.

Relative Value: ABS

  • The lack of spread tiering for the subordinated tranches of recent subprime and prime auto loans ABS leads analysts at Bank of America to prefer prime auto-loan ABS, according to a recent research note
  • There was no spread difference between the single-A rated tranches and only three basis points for the triple-B rated tranches, according to analysts
  • The timeshare ABS sector offers more compelling spreads relative to the subprime auto loan ABS, leaving BofA analysts to favor the timeshare sector over the subprime auto loan ABS
  • Finally, BofA said the student loan ABS sector looks relatively attractive, especially FFELP ABS. Spread levels remain wide of trading range minimums, and in the FFELP sector, remain wide of pre-Covid averages

Quotable

“We’ve seen office property perform fairly well through the pandemic,” Jen Ripper, CMBS investment specialist at Penn Mutual Asset Management, said in an interview. “The long-term nature of the leases, and the fact that there isn’t a lot of lease roll, helps it. Of course, this will play out over the course of years. CEOs have more time to think about what their future need is for space. They may end up utilizing it differently. If you are a tenant in a major city, you will have some leverage in what your future rent may look like. But many people may want to go back in and have that in-person experience with teams and collaboration.”

What’s Next

ABS deals in the queue for next week include De Lage Landen (agriculture equipment ABS), MassMutual (equipment), Octane Lending (power sports equipment), and Marlette Funding (consumer loans).

©2021 Bloomberg L.P.

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