US CLOs braced for further tightening
US CLO debt is at its tightest levels since the financial crisis, but with seemingly relentless demand spreads are set to get even tighter once the primary market builds up steam, according to bankers.
The US CLO primary market has got off to a typically quiet start, with the first new issue deal still to be sold, although two new deals have been marketed to investors this week.
Jefferies is marketing a new $376m deal for Par-Four Investment Management, Tralee CLO IV, the manager’s first deal since August 2014. DoubleLine Capital is also marketing its third CLO, Parallel 2018-1, with Citigroup on the mandate as arranger.
In the last deal sold in the market before the Christmas break, from LCM Capital Management, the triple-A notes were sold at 107bp over Libor.
But the levels being discussed in the market now are around 103bp for deals where there is an anchor triple-A buyer, and 105bp when the tranche is syndicated, say bankers.
“I think the spread tightening trend in CLO debt is set to continue,” said the head of credit investments at one bank in New York on Thursday. “This year might be the year triple-A spreads finally come inside 100bp, and there is chatter it could go as low as 78bp. Demand for CLOs and loans is so strong that it’s very difficult for investors to push back,” he added.
Despite widespread appetite for CLO debt there are still pockets of relative weakness in the mezzanine part of the capital structure — often seen as ‘in-between’ tranches, between the lower risk, lower yielding triple-A notes and the more juicy junior notes.
Brad Larson, head of CLO origination at Credit Suisse, said that while debt demand was overall strong, single-A demand was comparatively the most tricky part of the debt stack to place at the moment.
“Single-A demand is not quite as strong, and double-A demand can feel a little light if the entire triple-A tranche is covered by one or two investors,” he said. “If possible we strive to hold back some triple-As for double-A investors that like to pair double-A and triple-A investments.”
DoubleLine has also been marketing a refinancing of its 2015-1 CLO this week — price talk on the senior triple-A notes is at 85bp, well inside the 145bp level they were sold at in June 2015.
JP Morgan dubbed 2017 “the year of the refi/reset” with $98.7bn of refinancing and $51.6bn of reset deals sold during the year, both all-time annual records.
This year the volume of refi deals is likely to drop, however. The bulk of deals that have been done took place under the scope of the Securities and Exchange Commission's Crescent no-action letter, which allowed CLOs priced before December 24, 2014, to be refinanced without the manager being required to stump up new risk retention capital. The supply of eligible deals has now dwindled.
Reset transactions are expected to remain popular however as they allow managers to extend the life of existing portfolios at a time when loan assets are scarce and expensive. They also give managers a chance to reset the deal documents, allowing them to loosen the spread and rating tests they must maintain in the portfolio.
The 2016 vintage of deals in particular has been flagged as coming under pressure on the weighted average spread test in particular, given the wave of loan refinancing deals that managers have been forced to accept since then, meaning there will likely be a wave of 2016 deals being reset this year as they exit two year non-call periods.
According to JP Morgan, around $70bn across 160 deals highly likely to be reset or refinanced this year, although activity is likely to be skewed towards reset deals.