NEW YORK, April 22 (LPC) - The US Collateralized Loan Obligation (CLO) market grew to more than US$600bn in March, the first time the asset class has topped that size, even as fund spreads remain challenged.
The outstanding CLO market, the largest buyers in the US$1.2trn leveraged loan market, has been growing since the credit crisis, increasing by 119% between January 2013 and the end of March, when the size of the market rose to US$600.52bn, according to LPC Collateral data.
There has been US$39.4bn of US CLOs arranged this year through April 19, inline with the US$38.7bn sold during the same period last year, according to the data from LPC, a unit of Refinitiv. A record US$128.1bn of US CLOs was arranged in 2018.
US CLO issuance this year has been challenged as spreads on Triple A tranches, the largest and most senior piece of the funds, have continued to widen, hitting an average of 136.2bp in March, slightly tighter than the more than two-year wide of 138bp in February, according to the data. The wide spreads can cut into returns paid to equity holders, who are paid last after all other debtholders receive their distributions, and may cut into overall issuance.
“Spread levels on US CLOs still look relatively attractive compared to other securitized products and corporates,” Collin Chan, a CLO strategist at Bank of America Merrill Lynch, said in an email.
The current level for CLO Triple A spreads compared to about 25bp for Triple A credit card tranches or 62bp for non-agency, five-year Triple A commercial mortgage-backed securities slices, according to an April 1 Wells Fargo report.
“Although the arbitrage for new-issue deals has compressed, (CLOs) are still getting done because equity investors still find the levels acceptable,” Chan said. “Insofar that we do not see significant spread tightening in the loan market while CLO spreads stay wide, dealflow could certainly continue.”
The pitch of rising payments from floating-rate products including loans and CLOs lost some of its luster after the Federal Reserve (Fed) stopped raising rates. The regulator halted its rate-hike run late last year, and indicated in March that it does not foresee any increases in 2019. Fed policymakers said their decision about the appropriate target range for the federal funds rates would depend on their ongoing assessments of the economic outlook, according to minutes from the March 19-20 meeting released April 10.
Banks have cut their 2019 forecasts as wide spreads cut into refinancing and reset volume, which is significantly behind 2018’s pace, with just US$9.1bn arranged in the first three months of the year compared to US$31.2bn in the first quarter of last year.
“Given the pricing dynamic, we’d expect CLO issuance to decline year-over-year,” Jonathan Pruzan, Morgan Stanley’s chief financial officer, said during a question and answer session for the bank’s first quarter earnings. “But it’s been pretty healthy in the first quarter and it’s supporting a pretty healthy leveraged loan market.”
Barclays last month cut its forecast for US CLO refinancings and resets to US$40bn-US$55bn from US$95bn-US$110bn, while Wells Fargo revised its CLO forecast for refinancings and resets to US$45bn from US$100bn, according to research reports.
JP Morgan revised its new-issue US CLO forecast in February, calling for US$115bn-US$125bn of volume this year. It had originally predicted US$135bn. In January, Bank of America Merrill Lynch lowered its prediction for CLO refinancings and resets to US$55bn from its original forecast of US$100bn.
Even with the challenges, managers continue to raise US CLOs, with more than US$10bn of funds arranged in the first three weeks of April, according to LPC data.
“CLOs are an important business for a lot of asset managers and they are committed to it even when the funding costs aren’t optimal,” Brad Rogoff, head of credit research and strategy at Barclays, said in an email. “That being said, if the arbitrage challenges remain, we believe growth will slow even if it remains net positive.” (Reporting by Kristen Haunss. Editing by Jon Methven)