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Sam Robinson

The European CLO machine is slowly churning with market participants telling 9fin that 15-20 managers are in the primary pipeline. But with the pricing window likely to close at the end of October/beginning of November, according to one manager, there could be a rush to get deals done.

This could mean CLO new issuance volumes (€18.6bn YTD), are on track to be a lot closer to 2022’s volumes of €26.2bn than might have been expected.

But managers could face a slow-down with the iTraxx Crossover index jumping to 458bps this week (having been as tight as 375bps at the end of July, albeit before the 20 September roll to series 40) leading to a slight softness in the wider credit market. It also points to loan allocations getting trickier with huge demand for loan paper and triple-A spreads unlikely to tighten drastically.

“Some managers want to come to market by October/November but are at only €50m,” said one CLO manager, referring to ramp levels. “I would tell them to pack their stuff and wait for next year.”

The age-old problem of weak arbitrage between CLO assets and liabilities has resurfaced, investors say. This means managers are relying on captive equity vehicles. 

The good news is that out of 70 'open' European CLO warehouses (around 50 managers), “50% of those are less than six months old, nearly 40% are 6-18 months old and only 10% have been open longer than 18 months,” according to data from Maples & Calder, indicating there is no pressure to term out vehicles.

Ares (Jefferies), Blackstone Credit (Morgan Stanley), CVC Credit (BNP Paribas), GLG (Barclays) and Neuberger Berman are among some of the managers in the immediate pipeline, sources say. In GLG's case it will be coming back to the market after three years.

Prospective debut managers Arini and Sona are also soft marketing deals, according to investors, following recent debutant Pemberton.

CLO triple-As have priced around 168bps to 170bps in recent weeks, and last week 9fin reported Blackstone Credit was aiming to tighten levels even further with the lowest end of guidance for its triple-A tranche at 165bps.

Triple-A bids are healthy with some anchor investors placing tickets, according to investors.

"We've been hearing about some investors from Japan taking the entire tranche at around 165-170bps, so that's obviously creating supply and stimulating demand because deals are coming with triple-As fully placed,” said AnneMarie Flynn, head of structured investments at AIB in Dublin. “I think it is a positive thing in the market and should hopefully also stimulate demand for deals which are more broadly syndicated."

Another CLO investor, who has historically focused on mezzanine and equity tranches, says they have been heavily investing in triple-As and double-As recently, with clients wanting to “invest in the triple-As before pre-payments start to increase and every triple-A investor is sitting there with cash and needs to deploy”.

Despite the supply, Flynn doesn’t expect spreads to tighten much because “the investor base is what the investor base is”.

One European CLO arranger said: “There is still a little bit of work that needs to be done at the top of the capital structure. It’s the same equation everyone is trying to solve: cost of liabilities, economics on the asset side, loans have rallied again in the last few weeks and some loan repricings are now coming through as well.”

“CLOs are printing, there’s lots of liquidity and asset prices are still high but there’s just not as much primary on the loan side as the market wants — it’s coming. There’s been plenty of feedback with CLO debt investors but we are not there yet on the other side.”

Although triple-As are attractive on a historical basis with their all-in yield, on relative value they are less so, according to Copenhagen-based David Altenhofen, senior portfolio manager at PensionDanmark.

"In Danish mortgage bonds or govies, you suddenly can get around 4%. And that is in very liquid securities, which is also a valuable feature," he said. "One of the arguments for loans and CLOs has been the very low duration risk. It depends on where rates go from here, of course, but being underweight duration can hit you."

For the last couple of months, PensionDanmark has rotated into CLO triple-Bs in the primary market, he says, as CLO triple-Bs look more attractive than high yield corporate double-Bs on a relative value basis.

"There's been a huge bifurcation in high yield bonds, between double-Bs and triple-Cs,” added Altenhofen. “The corporate bonds I would like to buy, the double-Bs, are too tight at the moment – some around 200bp spread and 5% yield.”

“That is not super attractive versus getting 8% on a triple-B CLO. Even if we have a recession coming, with higher defaults and lower recovery rates, the CLO triple-Bs should be able to withstand the pressure, especially the newer deals with longer reinvestment periods, cleaner portfolios, and with conservative, experienced managers that can take sound credit decisions."

Managers that priced 2022 vintage CLOs after Russia invaded Ukraine in February 2022 are stuck with high financing costs on those deals. But, with short non-call periods ending, these are prime candidates for resets and redemptions. The landscape today is far more conducive to repricing CLOs with triple-As hovering around 170bps and the European Leveraged Loan Index last month hitting 96.68, levels untouched since May 2022. 

Six CLOs issued after the invasion of Ukraine last year are coming out of non-call periods this year and have a cost of debt of over 298bps. This is against an average of 265.6bps in the primary market in September — signalling a potential cost saving of over 33bps.

“2022 deals had expensive cost of debt but with cheap assets,” said one arranger. “Loans have rallied at or above par so now is a good time to reset and realise some of these gains, especially given some of these deals have come out of their one year non-call.” 

Orange Line: current triple-A benchmark, light blue: CLOs with cleansing notice, dark blue: confirmed reset, red: Redeemed CLOs. Source: 9fin data

Several managers have issued cleansing notices, as previously reported by 9fin. Among them are Anchorage, Axa, Barings, Napier Park and Onex. 

Equity investors in Redding Ridge and Napier Park CLOs have called RRE 14 and Henley CLO IX, while investors behind Sound Point Euro CLO IX have directed a redemption of a 30-times levered European static CLO and Alcentraliquidated its 2017 deal.

9fin also reported last week on investors in an Anchorage CLO liquidating a European CLO warehouse.

Managers may have to move quickly to reset deals, with one PM suggesting a slight widening of spreads could set in before the end of the year. Anchorage has already cancelled the reset of Anchorage Capital Europe CLO 6, according to a notice to investors seen by 9fin.

For equity investors, this is an opportunity to explore many options and some argue that seasoned investors are likely to outperform.

“It's an exciting time for CLO equity investors,” said Shawn Cooper, senior portfolio manager at Orchard Global.

“In a smooth functioning market, where deals are getting reset all of the time, CLO equity is like a permanent capital vehicle,” he said. “In such environments, deals don’t de-lever, which can result in similar looking profiles. Despite some performance variations, there isn’t as much differentiation — particularly in a low default environment.”

Today, however, there is a wide spectrum available.

“You need to have a view on triple-As factoring down, how much value to place on principal versus interest streams and manager behaviours,” said Cooper. ”Furthermore, some investors don’t always behave economically rationally, so there are many factors at play.”

Today's market “favours seasoned investors, who not only have a strong ability to do fundamental credit analysis, but also appreciate the necessity to analyse CLO structures and manager behaviours, over tourist investors who see potentially eye watering yields but fail to appreciate how strong a role the technicals can play in the outcomes of individual investments,” he added.

“The deals are shorter so the pull to par effect is a lot faster. We’ve seen a few of those where we buy something at 85-87 in primary last year and it's getting called/reset to par this year,” said another investor. “So it’s a tremendous pick-up in yield, in some cases even doubling the yield, that we hadn’t initially anticipated.”

The recent softness in the market, however, could impact when some managers come to market.

“We are seeing more and more resets in the pipeline, which was absorbed well until last week, but now there are a few deals that are on hold,” said one investor on Friday. “The dealers are trying to do the work behind the scenes and probably assess this volatility and where the market is headed. Today [Friday 29 September] is quite a strong day so maybe we'll see it start to pick up again.”

“Right now the fundamental performance of the market seems to be good,” said Flynn. “Obviously there have been defaults and downgrades to triple-C but the CLO asset class has very much weathered that storm so far. Equity and other markets are starting to see some wobbles right now and CLO performance tends to lag — if that's persistent there might be some nervousness in the CLO world again."

New Jersey-based Edwin Wilches, managing director and co-head of PGIM Fixed Income's securitised products team agrees: “We’re starting to see some softness in European spreads and getting some calls about being involved in deals and also from banks where a buyer has backed out. So I wouldn’t be surprised to see spreads go wider.”

Primary CLO equity in the current market is also not that attractive, investors say.

Switzerland-based Tarun Buxani, partner and portfolio manager at Alegra Capital says: “It’s difficult to see compelling equity plays in primary, whilst heavy CLO issuance during volatile periods may create a window to add risk in lower mezz tranches.”

“The best alpha generating opportunities will continue to be found in the secondary market, where equity can be sourced far cheaper than in primary and selective debt plays offer room for strong capital gains as some CLO structures amortise quicker than expected, or even experience outright calls.”

On the asset side of the equation, loan volumes have been quite low, although the pipeline has accelerated massively in the last few days.

“There’s a few P2Ps which underwriters have been working on but by the time they come to market it will likely be Q1 rather than Q4,” says one manager. “If you take away these A&Es, there’s not a lot of paper. It’s not great because it means either you don’t have a lot of pipeline, or if you have some pipeline it’s because terms are very tight.”

Loan allocations have been particularly tough for managers, with loans heavily oversubscribed. WorldPay, for example, was around four times oversubscribed, two managers said. 

Loic Prevot, senior portfolio manager at Polus Capital Management, concurs that “recent allocations have been a bit all over the place”.

"Recently we have seen two types of situations play out — one with new deals like WorldPay and Infra Group, in a context where managers want new paper,” he said. “Those started reasonably wide at launch but tightened significantly. Despite their tight pricing, demand has been very strong for these deals and allocations have been small.”

“On the other hand, existing issuers such as VMED or Altice International have also used the current window of strength to opportunistically tap the market. These deals have been upsized, and almost sized to demand, resulting in large allocations for some investors who were generally already existing lenders.”

Repricings have also returned to the market with 9fin reporting on Nord Anglia and Galileo. 

But rating agencies are looking at borrowers through a critical lens. 

“There’s definitely been a couple of downgrades to triple C, which are driven by refinancing pressures,” says AIB's Flynn. “Anecdotally we’ve heard of some borrowers proactively seeking to refinance well ahead of time in order to protect their credit rating.”

“If we have more of the — small — market softening that we have seen in the last few days, there could be a bit of resistance at some point,” said Prevot.

“But the reality is, most invested CLO portfolios out there run at a WAS (weighted average spread) of 400bps or below. So, if you have a 'good' credit with a margin of about 400bps post repricing, you will want to keep it. If it is B3-rated you might say that on a relative value basis there is room for improvement, but if you like and know the credit well, you may as well keep it in the portfolio.”

The tone from arrangers is generally more constructive, sources said.

“The number of sell mandates has been very high, however there remains a large valuation gap between buyers and sellers,” said one of the sources. “The good news though is that capital markets have re-opened, with more banks underwriting than at the start of the year, and sponsors can therefore get better execution in broadly syndicated markets.”

Yannick Le Serviget, global head of leveraged loans and private debt at AXA IM Alts, added: "It’s the right time to start ramping up a portfolio. If you target a brand new warehouse and ramp at current price levels of loans, with the trend of refis and dividend recaps, you need to be patient. A traditional ramp up of 3-6 months aiming for late Q1-Q2, would be perfect timing.”

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Q4 Euro CLO outlook — Sticky triple-As, loan allocation scrap and reset revivals

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