CLO secondary begins on a quiet note; analysts eye new issue prospects amid slow primary

By Rebecca Melvin

New York, April 27 – The CLO secondary market on Monday began the new week the same way that the old one went out: quietly. Last week, bids-wanted-in-competition volumes had been subdued in light of many market participants being away from their desks for the IMN Conference in New York, a New York-based trading desk source said.

“I would say it was consistent with last week. People are just getting back to their offices and hopefully by the end of this week, we’ll see more normal activity,” the source said of the secondary market.

Last week saw just $130 million worth of BWIC volumes coming to the U.S. secondary market, BofA Merrill Lynch analysts wrote in a note on Friday.

Spreads moved out by about 10 basis points amid a slack in demand, particularly for the approximately $61 million worth of AAA CLO 1.0 paper on the lists, the bank’s analyst said in their market overview.

Overall, market participants were “constructive” on the market, according to conference participant feedback, especially regarding risk retention and potential solutions including risk retention via majority-owned affiliates and via capitalized management vehicles.

“Market participants generally feel that the industry will be able to come up with something that works, even if it is not going to be a one-size-fits-all solution,” the BofA Merrill Lynch analysts wrote.

The primary market was quiet. A limited supply of bank loans will be a headwind for new issuance. The ratio of CLO to loan supply is 60%, a high not seen since May 2008, J.P. Morgan Securities LLC’s Jacob Kurosaki wrote in a note Friday.

CLO formation challenged

“CLOs can also buy secondary loans, but CLO primary appears to be running out of collateral to sustain the current pace,” Kurosaki wrote.

Opportunities remain for CLOs to buy discounted assets, albeit diminishing with the risk of loan repricings. Fifty-eight percent of single B loans trade above par versus 70% and 80% in the last two waves, when single Bs were 80% to 90% of activity.

Nearly 60% of year-to-date loan issuance is in five sectors. The CLO test including diversity must be supported. It is likely, JPMorgan’s Kurosaki wrote, that assets would need to be purchased in the secondary to hit target diversity scores, but as secondary loan prices rise, this could be challenging and time consuming.

“We believe that first-loss warehouse financing under the current environment warrants caution given extension risk of ramping a CLO,” Kurosaki wrote.

As issuance slows, “we look for further spread tightening,” BofA Merrill Lynch analysts wrote. At the current spread levels, U.S. CLOs remain cheap. Ultimate tightening will be dependent on how much issuance is tallied by year-end, the analysts wrote.

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