February 7, 2019 - CLOs are back in the news, with barely a hatchet in sight. The CLO market reopened, the WSJ found women bosses, the “CLOs are CDOs in drag” narrative was challenged, and several shops are rethinking their 2019 activity forecasts. We tackle these issues and more below.
First, the CLO market has reopened, though it’s only just beginning to normalize. LCD and Morgan Stanley saw $5 billion of January CLO formation, while Creditflux tracked closer to $6 billion. However, this wasn’t all regular-way business; three of January’s deals were short and one was a static CLO. By the end of the month (and early February), more normal five-year reinvestment/non-call two deals were re-emerging. That said, CLOs spreads are not low. Creditflux charted the US CLO 3-month term curve, and the January five-year AAA prints – at 130-150 bps – are well wide of late 2018 levels.
While Creditflux is tracking a pipeline of 42 deals, today’s wider prints might encourage analysts to rethink the 2019 forecasts. Most banks are keeping their new issue forecast in the $100 billion context. However, last week, BAML lowered its CLO refi/reset forecast from $100 billion to $55 billion as most newly callable CLOs sport AAAs in the 120-130 bps range, below the current new issue levels.
Beyond the revival of CLO issuance, we were pleased – dare we say astonished – to see some positive press on CLOs. After all, despite their long history of strong returns, including through the financial crisis, CLOs generally were pilloried in the press last year. For that reason, we reveled in a WSJ article that acknowledged that – despite sounding like CDO – “almost all CLOs performed well through the crisis”. Even better, the article discussed how four out of every 10 CLO bosses are women. (And while this fact isn’t in the article, we’d add that three of the women mentioned are current or former LSTA board members.)
Meanwhile, more market experts are pushing back on the “CLOs are CDOs in drag” narrative. First up, in Creditflux, Eagle Point explained that sounding like a CDO doesn’t mean a CLO is one. CLOs invest in leveraged loans and, rather than being small fly-by-night operations, many of the borrowers are large iconic companies such as Dell, American Airlines and Albertsons. Second, these loans themselves have performed well (positive returns in 24 of the past 26 years) and CLO safeguards make equivalently CLO notes perform even better. Eagle Point concludes with a warning that “cursory pieces lacking in thoughtful analysis and data” do a disservice to readers.
And speaking of thoughtful service, Wells Fargo explained why the comparisons of CLOs to 2007 subprime are overstated. We liked their list so much, we are republishing it. First, Ratings History: the rating agencies have long experience rating corporate credit; in the mid-2000s, subprime mortgage ratings were based on a relatively small history. Second, Underwriting: Corporate loan underwriting is much more robust than was seen pre-crisis residential mortgages. (See last week’s SNC review, which demonstrated how regulators still are telegraphing their expectations.) Third, Asset Class Consistency: The loan asset class is consistent and still used for the same purposes as in the pre-crisis days; in contrast, prior to 2003, sub-Prime mortgages were used for truly marginal buyers. Fourth, Structuring Simplicity: CLOs are fairly standardized with few changes in recent years; 2006-7 subprime CDOs were increasingly complex. Fifth, Non-Cash Derivatives: CLOs use almost no non-cash derivatives today; in 2006-7 subprime CDOs were primarily synthetic, outpacing the growth of the underlying market. Sixth, Real Money Buyers: CLO AAAs today are purchased by banks, insurance companies and money managers; pre-crisis, many AAA securitizations were purchased by SIVs and others. Seventh, Asset Diversity: CLOs have strict industry diversification requirements, which likely is more significant than geographic diversity.
Ultimately, the LSTA appreciates the thoughtful analysis and data that emerged on CLOs in the past week. While the reprieve may be brief, we hope our members enjoy it as well.