Global Corporate CLO Market Pulse: Record Issuance on the Cards? (2024)

Compared to 2023, the overall sentiment in the global collateralized loan obligation (CLO) market has turned notably optimistic, bordering on complacent according to some at the recent Global ABS conference in Barcelona. Spreads have tightened with many thinking there is room for further improvements. The European Central Bank has started to cut rates by 25 basis points bringing the main refinancing operations rate down to 4.25%, the deposit facility rate to 3.75%, and the marginal lending rate to 4.5%.

When looking at CLOs compared to other assets, deals are appealing on a relative value basis, with paper in strong demand. The consensus on the market is that defaults will reach 3–4% by year-end, driven by distressed debt exchanges. However, fundamentals are strong, with many participants feeling optimistic about how managers will handle these.

New Issuance in 2023

As of the 7th of June, European new issuance levels reached €22.7 billion, which is only €4 billion short of the total issuance volume of 2022 and 2023 (both around €26 billion).

From the U.S. perspective, new issuance sits around the $93 billion mark, with strong issuance in the refinance/reset area, as managers take advantage of the tighter spreads. Whilst refinancing activity has been higher in the U.S., the European market may have more collateral availability.

The issuance levels in the CLO market are currently being driven by a few key factors. Firstly, the carry remains strong even with tight paper, which continues to attract investors. Secondly, the market is recycling from called deals, as investors who exited due to amortization are keen to re-enter and deploy capital again. This has resulted in a net issuance rate of around 50% in Europe, whereas the U.S. is currently negative. Experts on one panel at Global ABS were leaning toward a net increase.

Thirdly there was the point that captive equity funds have helped increase issuance levels, with there being a 50:50 split between captive and third party. As spreads widened, the market saw mostly captive equity funds being used but the subordinated tranches are now becoming more attractive again.

Amortization & Callability of CLOs

The majority of 2019 deals are now out of reinvestment periods (RP), with many refinancing in 2021 as spreads tightened. Looking at the calls in the market, deals are facing challenges from the liability side when amortizing through loan refinancing, this in turn impacts the maturity profiles of deals. Older loans that are closer to maturity are more likely to be paid off or refinanced, which as mentioned leads to a reduction in leverage, making the equity more likely to call.

If we look at the average time for deals that closed between 2017 and 2019 and did not refinance, Trepp’s data shows it took on average 3.5 months for U.S. broadly syndicated loans (BSL) deals to start to amortize and 5.5 months for European deals. Interestingly, deals took 10 months in the U.S. and 15 months in Europe to amortize from a factor of 1 to 0.9. For deals exiting their reinvestment period, there is an interesting dynamic between the debt holder’s principal being paid back and managers trying to keep the deal levered to extend its life.

With longer-dated books, there is an increased chance that the Weighted Average Life (WAL) test will fail. CLOs that don't pass their WAL tests typically cannot agree to A&E agreements unless such actions would either maintain or enhance their WAL test buffers. We can see for the entire universe, 27.78% of deals are out of RP and failing their WAL, according to Trepp data.

If a creditor is unable to transition into a new loan tranche with a longer maturity, the borrower generally has to repay the creditor at face value. This kind of repayment is categorized as unscheduled principal proceeds, which usually can't be reinvested if the WAL is failing. Instead, they are applied to reduce the principal senior outstanding tranche, leading to faster amortization.

With the increase in deals being called, investors are getting money returned and are trying to stay reinvested. Furthermore, one expert at the conference pointed to the issue of post-RP and having difficulty reinvesting from pre-payment. For investors that are getting a lot of money in the door and need to stay invested, this creates an interesting demand for paper.

Liabilities Side of the Equation

The future of issuance will largely depend on the liabilities side of the market. Loan activity, driven by refinancings, resets, amend & extends along with mergers and acquisitions (M&A) and leveraged buyouts , needs to continue robustly. The market has seen some repricing due to the transition from private credit to BSL, which now constitutes around 20% of the supply.

Goldman Sachs stated at the conference that they hadobserved increased activity on the warehouse side, with record levels of mandates in the M&A team, further supporting this outlook. One caveat on the refinancing/repricing side of the liabilities is the impact it may have on arbitrage in deals, as spreads tighten.

U.S. vs. Europe: A Secondary Thought

The U.S. CLO market has experienced stronger spread compression in the secondary market, particularly at the top of the stack where spreads are historically tight. In contrast, the European market remains at the levels it was at around 2022. This disparity has led the U.S. market to refinance and call deals more frequently.

In the secondary market, spreads from AAA to BB are tighter than in the primary market, except for single B tranches which are wider. Investors can achieve a 30 basis points spread on AAA tranches, although there is an eight-week delay from investment. Securing AAA tranches with 1.5 to 2-year non-call protection is currently very attractive. Additionally, mid-life CLOs from the 2021 vintage are presenting attractive equity opportunities.

Investor Sentiment & Future Outlook

CLO investors are observing strong technicals but anticipate that any rate cuts are unlikely to occur until after the upcoming U.S. election, potentially as late as December. A vote among market participants showed that 73% believe the market will be net positive by year-end. Moreover, AAA tranches are well-bid, with the majority of the audience for the CLO Investor panel predicting that in July, AAAs would price between 130–140 basis points, barring any significant macroeconomic updates.

One panelist viewed that U.S. new issuance could reach $185 billion, though M&A activity may not match the peak levels seen in 2021, hindering this run. Morgan Stanley as of May 29th had revised their estimate to $165 billion. Previously Trepp had reported that Barclays also revised their forecast for BSL CLOs from $70 billion to between $105–$115 billion in a recent article by Bloomberg. While JPMorgan has also increased predictions to $130 billion from $110–120 billion to $130 billion.

European new issuance was last updated in May by BofA Global Research, according to Global Capital. The forecast for total new CLO issuance in 2024 has jumped from €27 billion to €32 billion, as deal flow has been strong since then it is possible for another revision. Overall, the main concerns in the market were if there would be enough loan supply to keep up with demand, and If investors could stay reinvested in paper with the rise of calls and amortization.

The information provided is based on information generally availableto the public from sources believed to be reliable.