December 8, 2022 - It has been a challenging – though perhaps ultimately rewarding – year in the CLO space. Despite a tricky arbitrage environment, as of earlier this week, US CLO issuance was $124 billion (from 270 deals). Of course, this is down materially from 2021’s record $181 billion (368 deals), but it’s within spitting distance of 2018 – the second-best year on record, Pitchbook LCD reported. As Refinitiv LPC reported and the COW charts, it’s remarkable that issuance has remained so strong with new issue CLO AAA spreads much wider than a year earlier. Of course, with AAA spreads continuing to sit in the SOFR+220 bps range, it’s no surprise that November was the fifth consecutive month with no refis or resets.
But enough about 2022. What is on deck for 2023? Most CLO analyst see spread recovery but – at the same time – more muted volumes than this year. New US CLO issuance forecasts range from $90 billion (BofA, of which $10 billion is middle market). Meanwhile, Barclays and Morgan Stanley are clustered in the $100-105 billion range and JPM is expecting flat CLO issuance in the $120 billion range. From a supply perspective, commentators point to a substantial amount of warehouses that do need to term out into CLOs. From a demand perspective, they look to what US and Japanese banks buyers are doing. Most feel that US banks may come back into the CLO AAA space – likely in second quarter or second half – as they continue to make substantial progress on capital requirements. (Indeed, Bloomberg suggests that JPM might be tiptoeing back into AAAs already.) In addition, the foreign exchange constraints on Japanese investors might ease. All told, investor demand may strengthen.
Combined, these supply and demand trends suggest that AAA margins – whose widening has largely been based on technicals, not fundamentals – have room to come in. A bit. Eventually. Barclays expects overall AAA spreads to initially widen from around 241 bps to 250 bps and then narrow to about 210 bps. MS’s base case is that once warehouses work off and bank buyers return, AAA spreads could narrow to 175 bps (and 125 bps in a bull case). JPM sees Tier 1 CLO AAA spreads coming back to the 190 context, down 30 bps from today.
Ultimately, we may be a bit smaller and a bit firmer. Not a bad New Year’s Goal.