UPDATE 1-CLO market eyeing tighter spreads to start year

(Adds Pacific Asset Management comment)

NEW YORK, Jan 17 (LPC) - The US Collateralized Loan Obligation (CLO) market is eyeing tighter spreads across tranches to start 2020 after coupons gapped out in 2019 to among the widest levels in two years.

Asset manager Pacific Asset Management on Thursday set the coupon on its Trestles CLO III at 133bp over Libor, tighter than the 137bp average for funds that priced in December, according to a source and LPC Collateral data. Some of the largest and most experienced firms may even push spreads on the senior slice of US CLOs into the 120bp range soon, market participants predicted.

Spreads on BB rated debt are also expected to tighten with investment firm Brigade Capital Management marketing this week the tranche of its new Battalion CLO XV at 635bp-655bp over Libor, according to two sources. BB US CLO debt had an average spread of about 761bp in December, though some priced as wide as 850bp, according to LPC Collateral.

“We are definitely seeing Triple A and BB tranches coming in at prices tighter than where they would have been a few weeks ago,” said Tom Majewski, founder of Eagle Point Credit Management, which invests in the equity and junior debt of CLOs.

The most seasoned managers may be able to price a CLO Triple A tranche about 5bp tighter now than they would have been able to in December, he said.

The US CLO market, the largest buyers of leveraged loans, recorded the third largest year of volume ever in 2019 with US$118.7bn of funds arranged, but lagged the record US$127.7bn issued in 2018, according to LPC Collateral data. US CLO issuance is forecast to fall in 2020, with banks calling for between US$75bn to US$100bn of volume.

“You have seen spreads compress across risk assets everywhere,” said Bob Boyd, a CLO portfolio manager at Pacific Asset Management. “Triple A CLOs stand out as a pretty attractive yield opportunity compared to where most Triple A assets have gone. We do think there is some room for the market to tighten.”

Much of the tightening for the Triple A tranche is driven by investors and their budgets – which for many, reset on January 1, Majewski said. Japanese banks, a large buyer of Triple A tranches whose new fiscal year will begin April 1, may also step back in with new budgets to begin buying even more deals.

Japanese banks own about 10% of the global CLO market, according to a Bank of England 2018 report.

Average Triple A spreads hit a 2019 high of 138bp in February, the widest level since about 146bp in January 2017, according to LPC Collateral data. Average senior spreads were as tight as 98bp in March 2018.

A spokesperson for Brigade declined to comment.

“Spreads should tighten, at least in the near term; the market feels very strong and technicals are quite positive,” according to Rishad Ahluwalia, JP Morgan’s London-based head of CLO research.

The bank is forecasting Triple A tranche spreads to be at 135bp by the end of 2020.

There are risks that could weigh on spreads, however, including macroeconomic and political issues, and any change in loan borrower earnings, he said.

“It feels like CLOs can tighten a bit more from current levels – the market can open the year on a strong note and we can see some progression,” Ahluwalia said. (Reporting by Kristen Haunss. Editing By Jon Methven)


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