CLOs to shrug off energy exposures, triple-As to tighten

There was around $125bn of aggregate CLO issuance in the US in 2014, a record high with the next highest annual figure the $97bn recorded in 2006.

That supply surge came despite the product grappling with the finalisation of the risk retention portion of the Dodd-Frank act.

“Risk retention is going to create opportunities and also challenges for fund managers to capitalise their companies,” said Michael Hopson, a senior CLO structurer at Natixis, during a panel at ABS Vegas on Tuesday.

In the early part of this year uncertainty over CLO managers’ plans to deal with the rules and concern over substantial exposure to oil and other energy sectors have been occupying investors’ thoughts.

Steven Oh, global head of credit and fixed income at Pinebridge Investments, said he had been asked these two questions at virtually all his meetings at the conference this week.

“On risk retention the vast majority of managers will likely be saying that they are exploring all options,” he said. “There are certain benefits with being early in the process with risk retention compliant transactions, where you can get better pricing execution potentially, but there are costs associated with it so it is a trade-off.”

“As investors, part of the equation you have to evaluate is which managers will not be surviving risk retention.”

Oh was bullish on managers’ ability to deal with their energy exposures, which have been troubling investors since the oil prices turned sharply downwards at the end of last year.

“It may not be a popular opinion but dislocation often creates the best opportunities,” he said. “If you close your eyes and wake up two years from now, energy will be the best performing sector. But there’s going to be a lot of pain along the way.”

However, the buoyant market faces other challenges, such as bringing back equity investors, said Amit Roy, head of CLO structuring at Goldman Sachs, during the conference panel.

“We’ve seen a lot of equity investors on the sidelines, not because they fundamentally dislike the asset class, but because they feel that on a relative value basis equity is expensive to what they can get in secondary," he said.

“For the equity investors to deal with the incremental volatility and the incremental risk the risk retention poses, they are going to require higher yields, and the only way that is going to happen is for triple-A spreads to compress over time.”

Roy said he expected issuance to slow this year relative to last, causing triple-A spreads to tighten, a move that should be exacerbated by an interest rate hike.