Another record year in CLOs

Another record year for CLOs in the USA and Europe, but next year’s issuance levels seems less rosy but “still ok”.

At least this is what the consensus was last week in Dana Point where approximately 1,500 CLO and Leveraged Loan professionals met at Opals CLO Summit.

This year the summit was, according to Opal, well attended by a growing number of (new) investors, like Pension Plans, Insurance Funds and Family Offices. As always, and no rules broken here, during this Summit investors and managers where tied up almost all day in their meeting rooms.

It is anticipated that US CLO issuance will be around $130bn, from 2014 heights of $124bn. In Europe 2018 will end up in the books as post-crisis CLO record year with levels around or just below €30bn. 2006 still holds the record with €35bn.

The main drivers of this year’s record-breaking issuance levels on both side of the pond are to a certain extend similar. Healthy conditions such as economic growth and a fundamental, sufficient supply of leveraged loans with investors simultaneously searching hungrily for yield which they can find in the historically low defaulted CLO paper. Whereas in Europe many investors might have been sentenced to the CLO markets as the ECB is scooping the majority of MBS and Corporate bonds away from them, in the US investors prefer floating rate debt in an environment with rising interest rates.

But… when printing the deals in the last months we have seen the spreads on the triple A’s widening from 70ish earlier this year to 100+ more recently. In the US we have the same pattern of spread widening to 120ish from initially the 100 range. At the same time the interest rates on the loans still seem to contract and, combined with liability spreads widening, the arbitrage is carved out and the joy of a CLO manager as well, as someone has to give in to make the deals work…

While in prior years events like this were always dominated by regulatory issues or shortage of a fresh and juicy supply of leverage loans, it seemed that this year we moved a bit further on the credit cycle. Hence the content of many panels dealt with possible increasing corporate defaults and other macro-economic shocks we might expect. It was a bit like a walk down memory lane as I’ve attended similar panels back in the days – before the crisis – discussing Cov-lights, loosening of loan and transaction doc’s, increasing leverage, second lien etc.. But we also know that CLOs did withstand the crisis and came out relatively unscathed and that fact is the best marketing tool one could think of.

And then the regulatory chapter. This time it was not as ‘doom, gloom and Armageddon’ compared to prior years. Whereas in the US we have seen the risk retention requirements dropping off the table and some repairs in the Volcker rule pending, it seems that Europe is diverging even further away from all of this. The ESMA (they never let us down on new regulations) released in August draft standards that require the reporting (and updating) on a quarterly basis of numerous data points, as part of the EU Securitisation regulation implementation which should increase disclosure and transparency for the investors.

Not surprisingly, this brought -again – a huge wave of displeasure amongst the European CLO market participants, as they had just recovered from the painful and overly interpreted Risk Retention implementation. However, in one of the last panels on Friday “Crystal Balling the CLO Market – what lies ahead” the latest breaking news was shared that ESMA delayed the disclosure requirement due to “market concerns raised” and that it was unlikely that they would be finalized and implemented by 1 January 2019. Rather, some transitional clauses will apply but that seems at least not completely unworkable. Regretfully, but not unexpected though, this leaves the European market in uncertainty again.

Another rumor that was quite audible at the Summit was that the Japanese regulator is eyeing  something that would adversely impact the CLO buyers. For instance that investors may only acquire CLO notes which comply with the 5% risk retention rule (euro-style) and that otherwise a higher risk weighting will apply. Another reason may be that the Japanese regulator is merely searching for increased risk weightings in general. To be continued…

During the whole Summit and also in my Panel on Crystal Balling the CLO market I’ve heard expectations for 2019 US Issuance somewhere in the range of $90-140bn and for Europe €25-30bn.

In summary the atmosphere was prudently positive, we cannot break records every year, or as an investor told me, even if we do issue minus 10-15%, next year it is still not bad at all!

Huub Mourits

Head Structured Finance & Capital Markets Services

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