CLO issuance has slowed in July.
Two deals printed during the first half of the month for a total of $826.1 million: Blackstone GSO’s $513.6 million Gramercy Park CLO and Jefferies Finance’s $312.5 million JFIN CLO 2012. That compares to a $4-billion-a month pace during the second quarter, when issuance spiked to a four-year high of $12.1 billion.
July’s slowdown can’t be written off as solely a typical summer swoon, managers say. Rather, rising liability spreads and falling collateral yields have conspired to thin CLO arbitrage, nicking CLO equity returns.
Start with liabilities. Blackstone/GSO’s $500 million Gramercy Park CLO print on July 12 shows that L+150 is now where the conversation starts on AAA discount margins, up from clearing levels of L+130-135 when the market was running hot in the spring.
AAA spreads have trended higher for a few reasons. For one, managers say the ranks of AAA buyers have thinned to just a handful in recent months in response to Europe’s difficulties, a series of worse-than-expected economic reports, and the fallout from the various banking scandals. For another, managers say that some buyers have had their fill, at least for now, after the relative CLO bonanza of the first half, when $18 billion of new deals cleared, including roughly $11 billion of AAA notes.
On the other side of the ledger, the loan market’s recent rally has driven down collateral spreads. The average yield to maturity of the S&P/LSTA Loan 100, for instance, fell to 5.82% on July 12, from a peak second-quarter reading of 6.31% on June 5.
Given these trends, managers estimate that model IRRs for CLO equity have retreated to 12-14%, from 15-17% earlier in the year. Understandably, then, participants say raising equity dollars – particularly in the open market – has grown more difficult. As a result, the number of managers able to ink a new CLO may contract after expanding early in the year beyond the large platforms and private equity affiliates that dominated issuance in 2011.
The challenge, managers say, goes beyond thinning arbitrage. At a more basic level, it’s difficult to source paper in today’s market because seasoned paper is largely tucked away – and sometimes selling at prices higher than axe-sheet levels – and the new-issue calendar remains lackluster. This is a particular issue for smaller managers that don’t have the capacity to pre-assemble portfolios before raising a CLO, managers say.
With all of this in mind, managers expect a trickle of new issuance during the summer months. The calendar remains chock-full of deals, but the number that appear imminent has faded. Further out, participants remain hopeful that the CLO market will click back into gear after Labor Day if AAA liability spreads narrow and, as most participants expect, new-issue loan volume picks up.
Well Fargo CDO strategist David Preston, for one, predicted in a July 12 report that AAA spreads will narrow to L+130 by year-end. Based on that, Preston affirms his forecast that CLO issuance will total $8-12 billion over the balance of 2012, bringing volume to $25-30 billion. Likewise, JP Morgan CDO analyst Rishad Ahluwalia is keeping his $30 billion 2012 estimate in place. – Steve Miller