March 1, 2017 - SFIG Vegas, the major West Coast securitization conference, had a different – and much happier – tone this year. This change was detailed in a Leveraged Loans and CLO Outlook Panel moderated by LSTA EVP Meredith Coffey. For instance, during last year’s conference, the average secondary loan bid was sitting below 90 cents on the dollar and the average all-in spread on new B+/B term loans was over LIB+620. Fast forward to today and secondary loan prices have rallied nearly 10 points (to the 98 context) and new issue B+/B spreads have fallen below LIB+400 – down more than 200 bps.
Likewise, last year was dominated by how CLOs would survive the turmoil in commodities. This year, it’s all about the struggle to find loan assets at attractive yields. As the panelists noted, this year, loan repricings have been rampant, with more than $150 billion of repricing activity to date. And, while we are probably two-thirds through the repricing wave, that also means there still may be a ways to go. With loan spreads contracting so quickly, the CLO “arbitrage” – the difference between the weighted average spread of a CLO’s assets and its liabilities – is under significant pressure. As slide 10 of the panel presentation demonstrates, the arbitrage has shrunk by 200 bps since early 2016. While CLO formation has picked up steam in February – we are up to $9 billion of CLO issuance year-to-date – the arbitrage (and risk retention) makes it harder to get moving in earnest.
So what can CLOs do to address the arbitrage challenges? For one, they can refinance. Indeed, more than $23 billion of CLOs have refinanced – and recalibrated the arbitrage – this year. The vast majority have used the Crescent No Action Relief letter to facilitate these refinancings. The Crescent letter, which the LSTA helped to facilitate, permits CLOs issued prior to Dec. 24, 2014 to refinance once without incurring risk retention. And this activity is expected to continue. One of the structurers on the panel noted that their institution alone had a $20 billion CLO refi calendar.
The panelists also offered other bits of good news. First, the credit cycle may no longer be in its waning days. With the commodity cycle perhaps behind us and the economy hopefully in an expansionary phase, default rates may remain low. Second, CLO liability spreads are coming in quickly as the investor base expands. Last week, a CLO AAA note was issued at LIB+126, and panelists thought that it would be reasonable to see LIB+100 this year on the AAAs. If the arbitrage right-sizes itself, CLO issuance could be robust. When surveyed, 20% of the audience said they could see CLO issuance above $85 billion this year, while another 18% saw $75-85 billion as doable. Still, that means the majority of respondents see issuance below 2016 levels: 35% said it would be $65-75 billion, 15% saw $50-65 billion and 11% saw issuance dropping below $50 billion. See more commentary on the panel from ThomsonReuters LPC and Asset Securitization Report.