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Credit cycle ‘nowhere near’ turning point for European CLOs

By Max Adams
06 Jun 2018

A panel of CLO experts speaking on day two of Global ABS agreed that the market in Europe is operating a near peak efficiency, and that the market is “nowhere near” a turn in the credit cycle for at least the remainder of this year.

“Every single year we do panels here and every year we get asked ‘are we turning’? It has been that way for nine years,” said Rishad Ahluwalia, managing director at JP Morgan. “On the macro side, the does not suggest we’re anywhere near a turning point in 2018.”

The CLO Market Outlook panel was markedly upbeat in its predictions for the asset class, highlighting an equilibrium that the market has settled into with regards to the different needs of the three primary parties – managers, triple-A buyers and equity investors. Dushy Puvan, head of CLO origination and structuring at BNP Paribas, said that deal documentation has become much more neutral, and less skewed to the demands of one group over another.

But although the CLO market is in cruise control at the moment, credit is declining somewhat, and the panel pointed to the insatiable demand for leveraged loans in both Europe and the US as problematic. Still, Moody’s analyst Carole Gintz told the audience that the rating agency is actually predicting the overall corporate default rate to decline from 2% to 1% this year.

The speakers also touched on the idea of manager tiering, as new issuers enter the market and investors become spoiled for choice when picking deals to invest in. Unlike in the US, where the view of tier one or tier two manager is based on investors’ opinions of the manager’s ability and will heavily influence pricing, tiering in the European market is an assessment of manager style.

“Investors are already pretty selective and it is great for them to have an even wider range [of managers] to invest in,” said Dimitris Papadopolous, head of structured credit syndicate at Natixis. “Investor choice really has to do with their long term commitment to the platform they are setting up in Europe,” he added.

With a slew of large institutional buyers playing in triple-As, and the attractive returns offered by equity, the speakers said that the junior tranches have become the most difficult to place, particularly and triple-B bonds.

“There are groups of investors that like single-A, so triple-B is probably the toughest to place right now, also because the people who buy triple-B in Europe also buy triple-B in the US and always look for relative value,” said Puvan.

Papadopolous noted that in double-A tranches, the difficulty in placing those bonds can be seen in recent price movements, with the bonds hovering around 100bp earlier this year but now having shot back up to the 135bp-140bp range.

Still, the obstacles that could constrain the market are few, and Ahluwalia said that the rest of 2018 could see more spread compression at the triple-A level than people expect, as demand shows no sign of waning.

By Max Adams
06 Jun 2018