CLO supply to start year slow, accelerate with new investors; new issue spreads remain tight

By Cristal Cody

Eureka Springs, Ark., Jan. 3 – CLO primary action is expected to start the new year light with some volume from deals that got crowded out of the primary market due to a heavy refinancing pace in December, according to Moody’s Investors Service.

“We expect U.S. CLO issuance in 2017 to start slowly but to eventually reach a total comparable to that of 2016,” Moody’s said in its monthly CLO report released on Thursday. “Participation by a growing group of Japanese and U.S. banks, South Korean insurance companies and European financial institutions will propel increased demand. The potential for new investors such as Chinese financial institutions would further boost demand.”

Refinancing activity in the CLO market, which hit a peak in the fourth quarter before U.S. risk retention rules took effect on Dec. 24, also will continue with more than 400 deals eligible for refinancing in 2017, Moody’s reports.

“There have been a historically high number of refinancings in 2016 in response to some CLOs’ liability spreads stepping up and favorable market conditions,” Moody’s said. “Risk-retention rules have ‘pulled forward’ some early 2017 issuance into 2016, while the heavy volume of Q4 refinancings may ultimately have the effect of ‘crowding out’ some 2016 new issuance, delaying it until 2017.”

The European primary market likely will see about €13 billion to €15 billion from 30-35 new CLOs in 2017 and with a wider investor base, including some interest from institutions in east Asia, primarily in the Aaa tranches, Moody’s said.

“We expect the pattern of one or two new managers per year to continue, most likely from U.S. CLO managers entering the European market,” according to the report. “The burden of risk retention, with which European firms have dealt for a couple of years, poses a high barrier to entry for many companies. An E.U. regulatory body has begun to consider raising the risk-retention requirement from the current 5% level to as high as 20%, but this is unlikely to have an impact within 2017.”

Tight CLO spreads

New issue CLO spreads are starting 2017 on a strong note, according to a Wells Fargo Securities LLC securities note dated on Tuesday.

Average CLO primary spreads were quoted on Jan. 1 at Libor plus 141 basis points for AAA, Libor plus 190 bps for AA, Libor plus 260 bps for A, Libor plus 415 bps for BBB and Libor plus 765 bps for BB.

AAAs were 14 bps better year over year, while A-rated tranches were 75 bps tighter, according to the Wells Fargo note.

“Despite the volatility and spread widening of Q1 2016, full-year 2016 was arguably the best year for CLO primary spread movement since 2012, in terms of spread tightening,” the analysts said. “In fact, 2016 saw the largest [year over year] spread tightening in AAA to single-A tranches since 2012; AAA spreads finished the year 14 bps tighter, AA spreads were 45 bps tighter for the year, and single-A spreads moved in 75 bps in 2016.”

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