Outlook 2021: CLO new issue, refinancing supply on upswing for dollar, euro primary markets

By Cristal Cody

Tupelo, Miss., Dec. 31 – CLO issuers finished 2020 better than expected as supply returned in both the dollar- and euro-denominated markets and with a bigger deal pipeline anticipated for 2021.

Issuance came to a standstill in March as the coronavirus pandemic lockdowns began around the globe and slowly resumed in late spring.

New issue volume through mid-December included more than $86 billion of dollar-denominated CLOs, more than €22 billion of euro-denominated CLOs and about $8 billion of middle-market CLOs priced, market sources report.

In 2019, supply included about $108 billion of dollar-denominated broadly syndicated CLOs, €29 billion of euro-denominated CLOs and $13 billion of middle-market CLOs.

“Even with moderate growth, the global CLO market is approaching a milestone $1 trillion outstanding in 2021,” JPMorgan analysts said in an outlook report, noting $815 billion of U.S. CLOs and €165 of European CLOs outstanding. “CLO activity has proved resilient but key constraints are supply of new loan collateral and CLO equity demand.”

Dollar-denominated CLO refinancing activity also resumed after the spring hiatus and continued into December with more than $32 billion of notes repriced, while the euro refinancing space stayed shut for the remainder of the year with only two CLOs refinanced ahead of the lockdowns.

In 2019, more than $41 billion of CLOs were refinanced, while euro-denominated CLO refinancing volume totaled €12 billion.

Refinancing activity is expected to rise in U.S. and European CLOs in 2021.

Meanwhile, the CLO secondary markets saw strong volume in the dollar- and euro-denominated spaces in 2020 as spreads retraced by the year’s close after gapping out amid the pandemic’s start.

New Year pickup

In 2021, new CLO volume is expected to range in the $85 billion to $110 billion area in the dollar space and €20 billion to €25 billion in the euro-denominated primary market, sources report.

About $10 billion to $15 billion of middle-market CLO issuance also is anticipated.

“The big picture is we believe economic recovery will roll on in 2021,” Chris Flanagan, head of securitized products research at BofA Securities, Inc., said in an outlook press conference. “We’ll get through the Covid shock by the end of the year. The overall theme we’re stressing is reduced duration and retreating yields. Both asset-backed and CLOs fit nicely into this perspective.”

The increase in issuance is expected to be driven by improving fundamentals in the loan market and pent-up demand from seasoned warehouses and managers who were in the primary market in 2019 but skipped issuing in 2020, according to BofA Securities research notes.

BNP Paribas Securities Corp. analysts expect CLO primary supply to grow in 2021 and keep demand strong for leveraged loans, according to a global outlook report.

CLO refinancing supply also is estimated to increase from 2020’s levels.

U.S. CLO refinancings came to a stop after spreads moved out in March, with the bulk of the year’s deals priced ahead of the pandemic’s start, sources note.

More than $25 billion of CLO notes were refinanced in the first quarter with refinancings at a standstill from April through June, according to a Kroll Bond Ratings Agency report.

“Most of the refis this year took place in fixed-rate tranches as the rally in swap rates made it economical to refi those into a lower coupon fixed-rate tranche, despite wider spreads,” BofA Securities analysts said.

Anywhere from $35 billion to as much as $60 billion of refinancing volume is expected in 2021.

BofA Securities forecast $30 billion each of refinancings and resets in the upcoming year.

JPMorgan expects about $35 billion of refinancing volume in 2021, mostly from the 2019 and 2020 vintages as the deals exit non-call periods with wider AAA spread levels.

Resets are likely for CLO AAA spreads of at least Libor plus 130 basis points or more if the deal is exiting reinvestment periods by 2023.

“These include most transactions that have been issued post-Covid considering their 3/1 [three-year reinvestment/one-year non-call period] or static nature, and relatively high AAA spreads,” BofA Securities analysts said.

CLOs that resumed pricing in the months following the pandemic’s start saw changes, including one-year non-call periods and three-year reinvestment periods that were shortened from typical pre-pandemic deals structured with two-year non-call periods and five-year reinvestment periods.

The pandemic also curtailed European refinancing supply, but a comeback is expected in 2021.

In 2020, just two CLOs totaling about €800 million were reset in February, sources note. Euro-denominated CLO refinancing volume totaled €12 billion in 2019.

In 2021, about €7 billion to €15 billion of euro-denominated refinancing volume is forecast by market participants on improved funding conditions and a large number of European CLOs that will be callable.

CLO ratings recover

2020 will likely go down as a record for downgrades – “significant downgrades which has never been seen before,” Pratik Gupta, head of CLO research at BofA Securities, said in an outlook press conference.

Moody’s Investors Service said that after the onset of the pandemic, loan prices were volatile and corporate credit deteriorated, especially in industries susceptible to the pandemic, including travel and dining.

“This deterioration resulted in the downgrade of 453 CLO tranches, about 10% of the tranches we rate,” Moody’s said.

Moody’s said it expects speculative-grade defaults to continue to rise through the first quarter of 2021 and decline thereafter, but as long as economic conditions and collateral metrics continue to improve, “bolstering investor confidence and tightening CLO spreads, new CLO issuance volume will likely increase moderately.”

Fitch Ratings assigned a stable ratings outlook for 2021 to U.S. broadly syndicated loan and middle-market loan CLO notes rated by the agency.

“As of the end of November, 97% of Fitch-rated notes issued by BSL and MML CLOs are on a stable outlook,” Fitch said.

European CLO notes also faced downgrades but proved resilient.

“Across all the rating agencies, on average, upgrades exceeded downgrades in European RMBS and auto ABS sectors, and downgrades exceeded upgrades in CLOs, CMBS and NPL sectors,” according to a BofA Securities report. “Downgrades were naturally concentrated in the sub-IG tranches, lower part of the capital structures, and very rarely affected IG tranches, be they senior or upper mezz.”

Since the beginning of the pandemic, about 60% of outstanding sub-investment-grade tranches and 40% of BBBs were placed under rating review by at least one agency with more than 80% of the reviews concluded by year’s end with ratings affirmations and actual downgrades limited to only 5% of outstanding notes, according to BofA Securities.

Spreads retrace wides

The securitized markets tracked the credit markets in 2020 and should follow that pattern in 2021.

“They move wider when they move wider and tighter when they move tighter,” Flanagan said. “We think corporates will tighten into the new year and then securitized products will follow that tighter.”

In 2020, secondary market volume was heavy in dollar- and euro-denominated CLOs, sources report.

The dollar-denominated space saw $1 billion trading volume weeks during the year.

CLO spreads mostly recovered after moving out in the spring across the capital structure.

“CLO spreads have staged an incredible recovery from their wides in March, retracing around 90% of their moves, although the mezz stack has continued to lag the broader market,” according to BofA Securities.

Secondary AAAs were ending 2020 at Libor plus 120 bps, in from the wides of 500 bps at the start of the pandemic and in line with top tier primary AAAs printing at a Libor plus 120 bps average.

AA tranches were closing the year at Libor plus 190 bps, improved from the 600 bps spread averaged in the spring, the BofA Securities analysts said.

BBB spreads were finishing 2020 stronger at Libor plus 360 bps after retracing from the wides of 875 bps, but still softer than the 310 bps tights of the year.

By December, secondary spreads had tightened through JPMorgan’s year-end 2020 targets with AAAs at 120 bps, versus a target of 135 bps, and BBBs at 360 bps, compared to a 375 bps target.

In 2021, JPMorgan said it expects “only modest compression” with AAAs forecast 10 bps tighter at Libor plus 110 bps and BBB tranches 35 bps tighter at Libor plus 325 bps.

The euro-denominated secondary market saw “unprecedented” BWIC volume in 2020, according to BofA Securities.

Supply over the year was estimated to include about €10 billion of BWIC CLO volume, up 140% from 2019, according to BofA Securities.

By the end of 2020, Euro CLOs retraced about 80% to 95% of the spread widening from earlier in the year.

“Back in March and in line with the broader credit markets, the pandemic outbreak caused major spread surges and price drops on European CLO market,” the BofA Securities analysts said. “CLO spread levels more than doubled across the capital stack.”

Euro-denominated AAA tranches came in by December to Euribor plus 107 bps from the spring wides of Euribor plus 300 bps with further improvement anticipated in 2021.

“We are bullish on euro CLO AAA, AA and A bonds as they have been lagging the broader market rally over the last three-four months,” according to BNP Paribas analysts, who expect 30 bps to 40 bps of tightening potential.

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