Nearly 200 active CLO lines of credit, paving the way for the market rebound
(Bloomberg) – Banks are ready to lend billions of dollars to fund managers to buy leveraged loans to embed in secured loan obligations when markets calm down and falling selling rebounds.
There could be nearly 200 active lines of credit, or warehouse lines, currently funding CLOs, John Clements, head of US CLO business at Barclays Plc, said in an interview. That’s roughly on par with the record number of warehouses opened last fall, which telegraphed what turned out to be an all-time high for CLO sales in 2021.
Volatility spurred by the Federal Reserve’s efforts to control inflation and Russia’s war in Ukraine hampered CLO sales with issuance down more than 20% from the same period last year. High CLO spreads and volatility in loan prices make it difficult to predict the profitability of creating a CLO, which dictates whether a deal goes ahead.
“Since there are so many warehouses available and in place, we think we can see some pretty healthy new CLO issuance over the course of the year,” CVC Credit partner Gretchen Bergstresser said in an interview.
“AAA CLO pricing is too dislocated,” meaning risk premiums are still too high, JPMorgan Chase & Co. strategists led by Rishad Ahluwalia said in a research note Thursday.
This leaves established warehouses – some set up months ago, others more recently – in limbo, stalled for now and at the mercy of CLO price swings and underlying collateral. .
While the large number of warehouses bodes well for the return of a strong show later this year, that may not happen anytime soon, observers say. The market needs to see more investors in AAA CLOs return as buyers to help drive demand, Bergstresser said.
“The ironic thing is that some of these warehouses are better off if they’re less developed,” or in the early stages of establishing the final loan security for the CLO, Barclays’ Clements said, as loan prices had fallen earlier in the month. , and lower prices on warranty are good for arbitrage. “During an expanding market, these will have a better chance of being realized because you can buy cheaper warranties.”
Wall Street banks are among the largest providers of CLO warehouses, which are the financing vehicles that CLO firms use to purchase and store loans before turning them into bonds.
The profitability of assembling a CLO – or whether it makes sense to do one – is called the arbitrage, or the spread between the interest earned on the underlying leveraged loans and the cost of borrowing to buy the assets. Healthier arbitrage improves trade economics, making it easier to attract CLO equity to sponsor new trades.
Arbitrage is more attractive when loan prices are low and CLO AAA risk premiums are tight.
Currently, risk premia on CLO liabilities, particularly AAA tranches, remain stubbornly wide. Loan prices have been volatile at best – reaching 15-year highs in January, dropping to 15-month lows in mid-March and rebounding slightly over the past five days.
“If you went out and bought all your CLO assets today, it would be difficult to create attractive arbitrage,” Bergstresser said, noting that rising loan prices in recent days haven’t helped. “Absent further downward pressure on loan prices, we still need to see a tightening in CLO liability spreads for the CLO machine to truly restart.”
Arbitrage has declined for most of this year, mostly inhibited by wider AAA CLO spreads. But lower loan prices at the start of the month made up for this, and as a result, at least nine CLOs were quickly struck on the market in just a few days in early March, as some managers took advantage of cheaper collateral, said Bergstress. But with loan prices rising in recent days, that window may have closed.
In the meantime, the fate of the warehouses – and whether their loans are underwater – differs from one manager to another and depends on various factors, including when the loans were assembled, the share of the transaction which has already ramped up, whether the manager has secured equity investors or AAA buyers, and whether the manager is willing to increase the size of the deal once loan prices fall again, Bergstresser said. .
There are many different levers they can use to push a deal forward, she added.
Relative value: CMBS
- Despite a notable decline in AAA CMBS versus lower-rated paper over the past two months, AAA SASB floats, AAA CRE CLOs and AAA last cash flow bonds offer considerable value and are well positioned to benefit from narrower spreads in the short term, especially in light of their recent underperformance relative to bonds at the bottom of the cap stack, Bank of America strategists said in their weekly securitization research report
- These picks may be a kind of “defensive positioning” amid continued uncertainty in Eastern Europe, shifting inflation expectations and the possibility of the U.S. entering recessionary waters in the coming months. next year, lament the strategists.
- Despite some widening in spreads, single-A corporate financial paper is currently offering significant recovery over LCF AAA CMBS conduit bonds
“While refi mortgage indices are currently at their lowest level since June 2019 (a far cry from some year-end noise in 2020), they remain well above levels seen in 2018 when the Fed was raising rates. interest,” said Scott Buchta, head of fixed income strategy at Brean Capital. “At that time, less than 20% of the conventional universe was refinanceable compared to 5% today. The big difference between the two periods has been house price appreciation, and withdrawal refis remain a significant driver of overall refinance activity (still 44% of all loan applications).
ABS deals pending for next week include Freedom Financial (consumer loan), Upstart (consumer loan) and Veros (subprime auto)
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