CLO primary market slower; spreads on higher-quality BB tranches have tightened

By Rebecca Melvin

New York, Nov. 16 – CLO issuance looks set to remain lighter as year-end approaches. But the limited new issue market in tandem with better relative value could lead to slight spread tightening even if year-end pressures prevent a stronger rally, Wells Fargo Securities analysts wrote in a recent CLO market note.

Spreads on higher-quality BB tranches have tightened to 775 basis points from 825 bps in mid-October, and the market is “on firmer ground” than it was in early October, according to the Wells Fargo note.

The bank is recommending that CLO managers clean up their portfolios ahead of year-end and ahead of any credit cycle downturn.

“We recommend investors stick to cleaner portfolios, as portfolio asset prices may currently have more downside than upside,” analysts David Preston, Geoff Horton and Mackenzie Miller wrote.

Currently CLO portfolios have 69% of loans trading above 98 and 5% trading below $0.80, and the outlook is for more loans above 98 to fall than for prices on lower priced loans to recover.

Last week Millennium Health, which announced plans to restructure debt in early October, filed for bankruptcy protection. The company’s term loan B is trading in the low 40s.

Many CLOs exited or reduced their position in Millennium in the last several months, according to the Wells Fargo analysts in a note published on Friday.

In a Wells Fargo report published in August, CLOs held a total of $560 million in Millennium across 189 deals. Those deals were mostly of post-crisis vintage. Currently CLO exposure to Millennium is $510 million across 172 deals.

The $50 million reduction in exposure came at a cost, given that the positions were exited at an average price of $0.46 on the dollar, but the initial par loss by exiting may have avoided further losses should the loan price continue to fall, Preston, Horton and Miller wrote.

The numbers speak in favor of cleaner portfolios – which seems to be the trend heading into this quieter part of the year.

Following Millennium’s bankruptcy filing, the loan market default rate hit 1.47% by principal amount, an eight-month high; the LCD shadow default rate, measuring the amount outstanding in loans that have missed a payment, entered forbearance agreement or hired bankruptcy council, rose to 1.75% this week from 0.84% at the end of October, and the LCD distress ratio, which acts as a proxy for future defaults, rose to 6% in October from 5.4% in September.

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