Tightening spreads and above-par prices in the secondary market have produced rich gains for many vintage collateralized loan obligations that have sold assets. But these conditions have forced managers to take newer deals to the rating agencies to lower weighted average spread covenants. "This year managers have sought amendments to reduce the minimum average spread on approximately 20 deals," noted Stephen Anderberg a Standard & Poor's CDO analyst. He said prior to the second half of 2003, few to none would do this.
The big difference for managers is whether the deal is still in its reinvestment period or is deleveraging. "Generally, there has been a positive trend in the vintage CLO market. There has been a stabilization in the number of defaults and also the value of the defaulted or distressed assets," said Marion Silverman, senior director in charge of performance analytics at Fitch Ratings. "Indeed, some deals that were downgraded have stabilized and have been restored to their original ratings," she explained, adding, "those managers who are able to sell older loans can harvest gains." Recent auctions of portfolios have demonstrated the sky-high prices in the secondary market. Two weeks ago Babson Capital Management sold a $128 million portfolio of loans to Deutsche Bank with a cover bid at 101.31 (LMW, 10/11).
This may be great for vintage deals, but "if a deal is still in the revolving period, managers are finding it difficult to identify replacement loans as the spread of new issues is significantly lower than a few years ago. Therefore, we are seeing many managers request amendments to lower the spread requirement," Silverman added.
Another consideration is when the deal was underwritten. The most recent CLOs are the best equipped to deal with the low spreads as the cost of the liabilities has plummeted alongside the collateral spreads. Pricing on triple-A tranches of CLOs have dropped over 15 basis points to around LIBOR plus 35 bps since the start of the year.
It also looks like spreads on loans have stopped falling. Peter Carnes, senior loan portfolio manager at CypressTree Investment Management Co. commented, "There appears to have been some stabilization in the spreads. The market seems to have set a level below which spreads should not go, at least for the time being, and there is minimal further erosion at the margins. That is not to say, however, that we are comfortable with where spreads are today." Carnes added that the pipeline is also looking up. "In terms of new deals, it's not the surge that people hoped for, but there are more deals and investors are being more credit-conscious. On the positive side the overall credit outlook remains favorable and there are no apparent signs of problems in the economy."