Robust demand for CLO exposure sent liability spreads to yet another COVID-19-era low in both the U.S. and Europe last week. But while there is no consensus over how far the current pricing compression may go — some expect spreads to eventually fall below the tightest levels since the global financial crisis — conditions nevertheless remain supportive for those managers able to ramp as well as for those seeking to address the cost of capital on older deals.
Year-to-date CLO new-issue volume, through Feb. 22:
* U.S. — $19.67 billion from 39 deals, versus $12.35 billion from 23 deals in the same period in 2020.
* Europe — €3.8 billion from 10 deals, versus €3.74 billion from nine deals in the same period in 2020.
* Global — $24.26 billion from 49 deals, versus $16.44 billion from 32 deals in the same period in 2020.
Recent trends continued in the U.S. last week as deals came through thick and fast, fresh triple-A and weighted average cost of capital tights were set, and the market moved yet further in favor toward five-year reinvestment period/two-year non-call (5/2) deals.
The latest manager to take the crown of tightest triple-A tranche and lowest WACC for a 5/2 deal in the pandemic era is CVC Credit Partners U.S. CLO Management LLC. BofA Securities was the lead on the $511.1 million Apidos CLO XXXV, which sports triple-As paying L+105 bps and a WACC of 142.1 bps.
At the other end of the scale last week was Vibrant Capital Partners LLC, with BNP Paribas pricing its $458.16 million Vibrant CLO XII with triple-As at L+123 bps and a WACC of 179.3 bps.
Triple-A spreads are marching tighter by the week. At the end of January, the tightest print at the top of the stack came from Oak Hill Advisors' $605 million OHA Credit Funding 8, at L+119. Since then, each week has brought a lower print, as in fact did many weeks in January. The tightest in mid-January was L+124 from the $429.75 million Sixth Street CLO XVII.
Whether this tightening leads triple-As to print below the tights since the global financial crisis remains to be seen, but on an average basis, it is getting closer. For the three months ended Feb. 15, the average triple-A spread was L+128 bps, while the tight on this measure was L+100 bps in the first quarter of 2018, according to LCD.
Analysts at Barclays think it is unlikely fresh post-crisis tights will be hit, with Geoffrey Horton and Jeff Darfus writing in a piece titled "Reaching for 2.0 Tights" that "Due to the sharp level of spread tightening, AAA tranches are the only part of the new issue stack that remain relatively wide versus other credit. … We think the combination of heightened CLO supply, increasing Treasury yields and the relatively low level of headline spreads could keep US BSL CLO AAA spreads from creating new post-GFC tights. Still, history suggests some tightening into the start of 2Q could be expected for AAAs, as relative value versus IG corporates remains high, with new issue spreads still c.15bp+ away from post-GFC tights."
Certainly, there has been a lot of new-issue CLO supply, and this will eventually begin to dampen demand for paper. Indeed, 39 deals have already been issued in 2021 for a total of $19.7 billion. This is already the highest deal count for a January and February combined, and there is still a week of the month to go. The previous high was 38 deals in the opening two months of 2018, for a volume of $21.4 billion.
Refinancings and resets remain a highly active corner of the market, driven by the aforementioned ongoing fall in liability costs. Last week, there were 14 refis or resets across the market, taking the total number of refinancings this year to 38 and resets to 20.
These deals were also popular early last year, with 31 refinancings and 15 resets printing in the same period. However, given how tight liabilities have become and their direction of travel, the refi/reset trade is expected to hold firm for longer. Indeed, there were no resets from March through September last year and only three refinancings from March through July.
Analysts at BofA Securities estimate that there are 11 deals with fixed-rate tranches in which managers/equity holders can realize at least 10 bps of cost reduction if they refi those particular bonds.
Environmental, social and governance
ESG compliant CLOs have grown in frequency in Europe and continue to be a key focus for that market (see below for more information on the latest green CLO). They have to-date been less in focus in the U.S. but many agree that this is likely to change, in part because this is the way the wind is blowing across all financial markets. Moreover, the Biden administration is perceived as being likely to have a more green agenda than the previous administration, while more U.S. companies are integrating ESG criteria into their reporting.
Analysts at BofA Securities have highlighted all this and more in their CLO Weekly report titled "ESG considerations in CLOs." The report adds that "Currently, CLOs with an ESG focus have 'negative screening criteria' excluding certain sectors from portfolios (we estimate at least 33 deals issued in 2020 had this criteria). However, we think the market is ripe for a change. We estimate at least 73 managers (64 US and 9 Europe-only CLO managers) have become signatories of UN's Principles for Responsible Investment (PRI)."
The European CLO market continues to be dominated by the compression of liability spreads, which some market participants expect will eventually extend to establish new post-global-financial-crisis tights.
Last week, triple-A spreads on primary European CLOs ground tighter once more, with the 80 bps spread on the €410 million Providus CLO V for Permira European CLO Manager setting a new COVID-19-era benchmark low.
Spire had tested the waters for a new market tight in the week prior, guiding the upper-most rated notes on its recent CLO at 80-83 bps, before pricing at 83 bps.
Permira's latest deal priced tightly further down the stack at 125/205/295/560/820 bps on the floating rate double-As to single-Bs on a discount margin basis, matching the current 125 bps tight for double-A tight notes set by Spire. The weighted average cost of capital on a coupon-only basis was 156.6 bps, which ranks as the third-tightest WACC for a European deal since the onset of the pandemic, behind RRE6 Loan Management and Avoca CLO XXII.
A €50 million portion of the class A tranche on Permira's latest deal is structured as a loan, ranking pari-passu with the class A notes, which multiple sources comment was driven by an investor preferring to have their exposure in a loan — rather than a bond — format.
The inclusion of the class A loan is understood to be a structuring feature likely not seen before in the new generation of European CLOs, according to investors. In a research note published Feb. 19, analysts at Deutsche Bank wrote that they suspected the inclusion of the class A loan had regulatory motivations.
Indeed, LCD understands there are a number of potential investors in the CLO universe that would receive better capital treatment by holding a loan versus a floating bond, while one investor noted that the inclusion of this type of structure in future deals could be a force for further liability spread compression going forward.
The Permira transaction is also the first new-issue European CLO arranged by Jefferies, which last year hired Laura Coady as co-head of its EMEA securitized markets group and Hugh Upcott Gill and Luis Leon Carsi as co-heads of its EMEA CLO primary business. The deal is also Permira's first new-issue CLO since the €207.6 million Providus CLO IV via Citi in April 2020, which was the first vehicle to reopen the market following the disruption caused by the onset of the COVID-19 pandemic.
On Feb. 22, another new issue European CLO priced from a manager that did not come to the market in 2020, with Commerzbank's €360.45 million Bosphorus CLO VI printing at 85 bps across the triple-As.
Further down the stack, the deal — led by Deutsche Bank — priced at 135/210/343/625/870 bps on the floating rate double-A to single-B notes on a discount margin basis, with a coupon-only WACC of 164.49 bps, according to LCD.
Scores on the doors
With the pace and depth of liability spread tightening exceeding most expectations, it remains difficult to build a consensus around how far liabilities may tighten in the short-term. One CLO manager last week said the market would soon see deals with seven-handle prints on the upper-most rates notes, while another manager told LCD that spreads could eventually move inside record tights, such is the demand for yield. The tightest print for a European 2.0 CLO triple-A tranche is 68 bps, which was achieved in 2018, according to LCD.
In a research note published on Feb. 19, analysts at Barclays wrote that while another 20 bps of triple-A spread tightening would be difficult to envisage (spreads are now 25 bps tighter than the 105 bps benchmark low in December), negative rates and sluggish loan supply could well spur triple-A spreads to reach new levels in Europe.
"We see a higher probability for European AAAs to tighten past post-GFC tights, though, at least into Q2 before supply weighs on demand. This is due to the prevalence of negative rates in Europe, potential headwinds in sourcing collateral and creating a drag on new CLO supply in the short term, and a higher embedded Euribor floor benefit than in years past, improving all-in spreads," analysts at the bank wrote.
The potential headwinds of sourcing collateral has become an increasingly prevalent topic for managers in recent weeks, with tight pricing on the asset side — both in primary and secondary — likely to slow down new CLO issuance for now.
However, it is this compression in liability spreads that continues to improve reset and refinancing prospects, which continue unabated. The recent €426.54 million reset of Blackstone's Dartry Park CLO via BNP Paribas priced with triple-As at 80 bps, which rank as the tightest triple-A spread for a reset so far this year.
CELF Advisors is among those currently marketing a reset on an existing transaction, with the triple-As on its proposed €434.25 million reset of Carlyle Global Market Strategies Euro CLO 2016-2 guided at 82-84 bps.
On the refinancing front, 60 bps remains the tightest spread for triple-A notes, with BNPP AM Euro CLO 2018 and Cairn Euro CLO IV pricing at this level, with reinvestment periods running off in October 2022 and April 2021, respectively.
Deutsche Bank is also leading the partial refinancings of CVC Cordatus Loan Fund VII and BlackRock European CLO VII. Both deals have broadly similar price talk, with triple-As of 63 bps and 62 bps, respectively, and will be the latest deals with reinvestment periods running off in 2023 to price refinancings in the low-60s.
Meanwhile, the strong compression in spreads has led analysts at Nomura to revise their forecast for CLO refinancings during 2021. Analysts at the bank now anticipate refinancing volume for the year to total €65 billion, up from roughly €40 billion, which suggests that around 50% of the outstanding CLO tranches that are callable in 2021 will be refinanced.
As of press time, nine refinancings of pre-2020 deals had so far priced this year, compared to six resets. Indeed, given the attractive spreads on refinancings — triple-As have ranged from 60-68 bps — the refinancing route has proven more attractive to equity investors on some deals than extending the life of the transaction. However, for those richly priced, smaller-sized pandemic-era deals that priced last year, resets are expected to be the name of the game.
It remains to be seen what impact this wave of refinancings and resets will have on market technicals as the year progresses. "With such a large amount of potential refinancing activity, capacity constraints for counterparties such as CLO managers, rating agencies and investors may come into play, which could push some of these expected refinancings into 2022," wrote Nomura's analysts.
* This story was amended at 11:41 a.m ET on Feb. 24 to reflect that Vibrant Capital Partners last week priced its Vibrant CLO XII.