NEW YORK, July 10 (LPC) - The US Collateralized Loan Obligation (CLO) market is on track for a record year as investors seek floating-rate products in a rising interest rate environment.
Wells Fargo is forecasting a record US$150bn of US CLO issuance this year, which would far surpass the previous record of US$123.6bn in 2014.
“A lot of activity comes from originators and managers that want to price deals and tap demand for floating-rate products,” said Rishad Ahluwalia, head of CLO research at JP Morgan.
Investors are targeting CLO tranches to hedge against further anticipated interest rate rises after seven hikes by the Federal Reserve since December 2015. CLOs are the biggest buyers of leveraged loans.
In the first six months of 2018, US$66.7bn of CLOs were issued, 27% higher than a year earlier and almost 10% ahead of the same point in 2014, according to Thomson Reuters LPC Collateral data.
Morgan Stanley was the largest arranger of new-issue US CLOs in the first half of the year with 14.37% market share, followed by Citigroup with 13.25% and Bank of America Merrill Lynch with 12.14%, according to LPC Collateral data.
A record US$79bn of deals have also been reworked or reissued so far this year, after a US Appeals Court ruled in February that CLOs are no longer subject to Dodd-Frank retention regulations that require managers to hold 5% of their fund.
“A lot of the and reset and reissuance activity [is being done] to take more expensive CLOs from 2015 and 2016 [and rework them] to more easily fit in today's loan market,” Ahluwalia said.
CLO equity returns have been pinched as their underlying loan investments have been repriced and borrowers switched to cheaper one-month contracts, leaving managers under pressure to reduce liability costs.
Refinancing CLOs can boost equity returns as it cuts the spread paid to debt investors, including the most senior Triple A noteholders, while resetting extends a CLO’s maturity.
The US CLO market has seen US$17.9bn of US CLO refinancings, US$42.1bn of resets and US$19.1bn of reissues in the first half of the year, according to LPC Collateral data.
“The first half of 2018 saw a significant increase in new issue and reset volume compared to 2017,” said Tom Majewski, founder of Eagle Point Credit Management. “CLOs from 2015 and 2016, typically with high liability costs, have been coming off of non-call, and proactive equity investors are driving resets of many of the CLOs from those vintages.”
US institutional loan issuance totaled US$470.5bn in the first half of the year, US$309bn of which backed loan refinancing and repricing activity, according to LPC data.
“In order for the second half to be as strong [as the first] you need a combination of arbitrage for CLOs improving and debt demand remaining at high levels,” said Steven Oh, global head of credit and fixed income at PineBridge Investments.
Triple A spreads were 105bp-118bp halfway through the year, but some senior tranches could be issued below 90bp by the end of 2018, Ahluwalia said, as CLOs succeed in reducing their liability costs.
The US market has seen a recent pushback in both CLO and loan spreads in June and July, but this did not dent CLO issuance last month, which was the second busiest of 2018 – a pace that observers expect to continue for the rest of the year.
“We expect the second half of 2018 to be just as busy as the first half, due to strong demand for CLO debt and equity, many second half 2016 vintage CLOs coming off of non-call , and many 2014 vintage CLOs seeking to extend their reinvestment periods via resets,” said Majewski. (Reporting by Kristen Haunss Editing by Tessa Walsh and Jon Methven)