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CLO Sighting: BlackRock Prices €410M Vehicle in European Market Debut

Credit Suisse has priced the €410.238 million CLO for BlackRock Investment Management (UK) Limited, according to market sources. The transaction is the manager’s first European CLO, and is the first to price in Europe in more than three weeks.

The structure has been revised since launch, with the single-B rated tranche removed. Discount margins were not released.

The revised structure runs as follows:

The closing date is Feb. 24, 2016, and the first payment date is Sept. 15, 2016. The legal final maturity is March 15, 2029. During the marketing phase, the non-call period was guided as roughly two years, and the reinvestment period as roughly four years.

For risk retention, the manager intends to retain a 5% vertical slice as sponsor. BlackRock Investment Management (UK) Limited is a MiFID registered entity.

For Volcker, the transaction will rely on Rule 3a-7, while the Class A, B, C, and D notes will also be issued in the form of CM removal and replacement non-voting notes or CM removal and replacement exchangeable non-voting notes, in respect of any CM removal resolution or CM replacement resolution.

This is the first European CLO to price in February, and BlackRock’s transaction takes the year-to-date tally to €0.82 billion from two transactions, according to LCD. — Sarah Husband

Follow Sarah on Twitter for CLO market news and insights.

This story first appeared on www.lcdcomps.com, LCD’s subscription site offering complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here.

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Leveraged Loans: Jurisdiction, Credit Risk at Heart of LSTA/SEC CLO Suit

A ruling on the LSTA’s suit against regulators over CLO risk retention may not be reached until just before the regulation is due to go into effect on December 24.

Much will depend on which court has the jurisdiction to hear the suit, a topic that was heavily debated at last Friday’s oral arguments at the D.C. Appeals Court.

If the appeals court has jurisdiction, a ruling could be expected by June or July, but it’s also possible that the case gets transferred to the lower D.C. District Court, pushing any ruling very close to the December 24 deadline.

In that latter scenario, the LSTA would likely try to speed things along, requesting an expedited hearing in addition to negotiating with the government to use the same briefs that were submitted to the appeals court to save time, but nonetheless another date would have to be set in the district court for oral arguments.

Adding to the timeline is the likelihood that the decision in the district court would be appealed regardless. The case would then return to the appeals court where a different panel of judges would ultimately rule on the merits.

The LSTA could also ask for a stay of the final rule from the judge, meaning that the deadline for CLO managers to comply with risk retention would not go into effect until the case is decided in the appeals court.

Friday’s developments mean that any relief for the CLO market around risk retention remains a long shot, but there was at least some encouragement that the justices on Friday seemed open to some of the LSTA’s arguments.

To recap, the LSTA is challenging the Federal Reserve and Securities and Exchange Commission (SEC) on three fronts related to the 5% retention requirement in December.

The LSTA argues that the regulators are misinterpreting the definition of a “securitizer,” not properly defining “credit risk,” and failing to consider potential alternatives such as the Qualified CLO.

If the courts rule that CLO managers are not “securitizers,” CLOs would likely be exempt from risk retention, while a ruling that the regulators failed to either properly define credit risk or consider alternatives would mean regulators may have to re-propose risk retention.

When the lawyer for the Federal Reserve explained the securitization process of CLOs and how the risk is transferred from the balance sheets of the banks to CLO investors, a judge asked, “but you weren’t saying these risky loans were ever on the balance sheet of the manager, right?” To which the Fed’s lawyer replied, “They never put them on their balance sheet your honor, that is correct.”

Thus supporting the LSTA’s argument that the CLO manager is not a “securitizer” because it has no ownership, possession, or control of the underlying loans assets when they are purchased and put into a special purpose vehicle (SPV).

The definition of credit risk was prominently debated in the latter part of the hearing. The LSTA argues that the government is under obligation to explain its rulemaking, and the agencies fail to clearly define credit risk, using only the term “fair value.” And while CLO managers can comply with the 5% risk-retention rule through a vertical slice, horizontal slice, or a mix of both, justices acknowledged their awareness that the horizontal tranche is composed entirely of the “first-loss” piece. Lawyers for the LSTA pointed out that the same 5% held in a vertical slice has a different risk profile because almost 80% (the AAA tranche) has very little credit risk.

While one of the judges appeared sympathetic to the LSTA’s argument on credit risk, another seemed to suggest that the government may have met its burden by proposing the 5% vertical slice.

The audio of Friday’s hearing hearing can be found here.

The case is The Loan Syndications & Trading Association v. SEC, 14-1240, U.S. Court of Appeals, District of Columbia Circuit (Washington). — Andrew Park

Follow Andrew on Twitter for CLO market news and insights. 

This story first appeared on www.lcdcomps.com, LCD’s subscription site offering complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here

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Leveraged Loans: Amid Global Volatility, CLO Market Players Stranded on Sidelines

 

global CLO issuance

It’s not getting any better out there for U.S. and European CLO markets, and with liability spreads continuing to gap out each week, some are speaking in terms of the primary market becoming dysfunctional. The stats say it all, with just $1.28 billion pricing globally this year versus $9.24 billion in the same period last year, according to S&P Capital IQ LCD.

Managers are marketing transactions in both regions, but with the ongoing volatility and the need to reduce fees on those investing in the CLO equity portion, few managers are actually able to price a CLO. Those that can are waiting for conditions to improve. Others with warehouses that are well ramped may be under increasing pressure to act.

Unsurprisingly, no transactions priced on either side of the Atlantic last week. – Sarah Husband/Andrew Park

Year-to-date volume:

  • U.S. – $830 million from two deals versus $6.95 billion from 13 deals in the same period last year
  • Europe – €410 million from one deal versus €560 million from one CLO in the same period last year
  • Global – $1.28 billion from three deals versus $9.24 billion from 17 deals in the same period last year

This story first appeared on www.lcdcomps.com, LCD’s subscription site offering complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here

Follow Sarah on Twitter for CLO market news and insights. 

Follow Andrew on Twitter for CLO market news and insights. 

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LSTA Opens Oral Arguments Challenging Regulator Views on CLO Risk Retention

The oral arguments led by the LSTA against the Federal Reserve and Securities and Exchange Commission (SEC) will take place today challenging the regulators’ interpretation of risk retention for CLOs.

Each side will present their case for 15 minutes tomorrow morning with a ruling expected around June or July.

The LSTA in the case, which has been filed in the U.S. Court of Appeals for the District of Columbia, argues that regulators are misinterpreting the definition of a “securitizer”, not properly assessing “credit risk”, and failing to consider alternatives such as the Qualified CLO.

If CLO managers are ruled not to be “securitizers,” due to judges siding with the LSTA that managers are neither directly selling nor transferring assets, CLOs would likely become exempt from risk retention, which goes into effect on December 24.

The LSTA also argues that regulators are misinterpreting the concept of “credit risk.” They argue 5% of the market value of a CLO held in the form of a vertical slice, a mix of the first-loss equity up to lower-risk senior tranches, would have a different risk profile than 5% of the CLO in all of the first-loss equity tranche.

On a third front, the LSTA argues that the regulatory agencies fail to properly explain their reasoning behind the implementation of the risk-retention rule, nor providing any sort of sufficient rebuttal to other proposed alternatives such as the Qualified CLO. “The Commission’s failure is especially stark because it must consider the effect of its rule of ‘efficiency, competition, and capital formation,’” the LSTA argues in its reply brief.

If judges rule in favor of the LSTA’s interpretation of credit risk or that regulators failed to sufficiently consider alternatives, regulators may have to re-propose the rule that would more likely entail 5% of the total equity instead of the entire transaction.

Still, while a favorable ruling would bring relief to a number of market participants across the securitized products sector, the likelihood of one is still considered to be a long shot.

The case is The Loan Syndications & Trading Association v. SEC, 14-1240, U.S. Court of Appeals, District of Columbia Circuit (Washington). — Andrew Park

Follow Andrew on Twitter for CLO market news and insight.

This story first appeared on www.lcdcomps.com, LCD’s subscription service offering comprehensive coverage of the global leveraged loan and high yield debt markets. 

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S&P Upgrades 80 Tranches on 24 CLOs in 4Q as Defaults, Exposure to Energy, Remain Low

Standard & Poor’s Ratings upgraded 80 tranches on 24 CLOs in the fourth quarter of 2015 as the issues have minimal exposure to defaulting and distressed issuers.

Analysts did not downgrade any CLOs during the quarter, but placed one tranche on CreditWatch negative due to its above-average exposure to the Oil and Gas and Metals and Mining sectors.

S&P Ratings analysts calculated the trailing 12-month non-investment grade default rate at the end of December rose to 2.8%, from 2.5% at the end of of the third quarter, the highest level seen since 2012. Analysts are projecting the rate will rise to 3.3% at the end of the third quarter of 2016. Still, these levels are below the 4.4% long-term average between 1981–2013. The trailing 12-month default rate of leveraged loans was 1.33% at the end of January, according to LCD data.

If you are not a RatingsDirect subscriber, you may purchase a copy of the report, available to S&P subscribers here, by calling (212) 438-7280, or sending an e-mail to research_request@standardandpoors.com. — Staff reports

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Babson Prices $407M CLO via Morgan Stanley

Note: This story was updated to reflect fact that this CLO, and another, via Voya, priced today, making them the first two such vehicles of 2016.

Morgan Stanley today priced a $407 million CLO for Babson Capital Management, according to market sources.

Pricing details for Babson 2016-1 are as follows:

Up to 80% of the loans in the portfolio can be covenant-lite, according to marketing documents.

The transaction will close on Feb. 23. The deal has a two-year non-call period, a four-year reinvestment period and an 11-year legal final maturity.

As the year’s first CLO to price in the U.S., year-to-date and month-to-date volumes are $407 million, according to LCD data. — Andrew Park

Follow Andrew on Twitter for CLO market news and insights. 

This story first appeared on www.lcdcomps.com, LCD’s subscription site offering complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here

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Leveraged loans: CLO Pros Eyeing Market Technicals, Fundamentals in 2016

J.P. Morgan has released the results of its CLO Client survey for 2016, which finds that fundamentals and technicals are the most concerning aspects of the year ahead, while also highlighting that more needs to be done by managers to demonstrate they have a clearly defined strategy for risk retention.

Key highlights include:

While investors are concerned with fundamentals, the market’s ability to absorb supply also ranks high on the list of worries.

US CLO volume

After fundamentals and supply/demand technicals, liquidity is the third biggest concern for the coming year, followed by collateral supply, and oil prices, with interest rates in sixth place.

For risk retention, participants saw some development in risk-retention strategies among U.S. CLO managers versus J.P. Morgan’s April survey, but still see room for improvement. 53% of respondents see less than half of U.S. CLO managers in the market having a clearly defined risk-retention strategy.

Investors may not have a large amount of cash to put to work in the coming year, 45% of investors reported holding less than 0–5% of their holdings in cash, but that number is off the highs of 60% of investors reporting the same level in the second quarter of last year.

When it comes to CLO debt, primary and secondary U.S. AAAs are considered to offer the best relative value, while U.S. secondary equity is also seen as cheap by more investors than in the last survey. There is interest in U.S. primary single-A, and there appears an increase in demand for European equity, in both primary and secondary.

Finally, the makeup of those responding to the survey has changed with debt investors, such as Banks and Asset Managers, substantially increasing their visibility in this quarter’s survey. Hedge funds remain the second-biggest constituent. For reference 91 clients took part in the survey. — Sarah Husband

Follow Sarah on Twitter for CLO market news and insights.

This story first appeared on www.lcdcomps.com, LCD’s subscription site offering complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here

 

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Leveraged Loans: 2016 CLO Outlook – Credit Concerns and Risk Retention in Focus

It’s easy to forget that 2015 has been the second busiest year for CLO issuance in the U.S., with the full-year volume total of $97.89 billion behind only the record $124.1 billion from last year. While activity was brisk in the first half of the year, with volume averaging $9.9 billion a month, the tone was markedly different in the second half as the pace dwindled to $6.3 billion a month. CLO managers and arrangers were confronted with volatile conditions in the second half that required creativity to get these transactions to the finish line.

monthly CLO volume

Of this year’s $97.89 billion total, middle market CLO issuance accounts for $5.81 billion via 14 transactions.

Refinancings, which are not included in the new-issue volume tally, total $10.2 billion in 2015 from 25 transactions. That figure includes resets where existing CLOs have their non-call, refinancing, and WAL tests extended.

Predictions for 2016, however, aren’t as positive. Weaker demand for mezzanine and equity tranches, concerns over more loans being downgraded to CCC, rising interest rates causing decreased cash flows to equity holders, and challenges from risk retention are all expected to contribute to lower issuance.

CLO market participants foresee a smaller new-issue calendar for 2016, with credit allocation remaining front-and-center as the credit cycle matures.

Bank analysts are universally predicting lower issuance:

  • Bank of America: $70 billion
  • Deutsche Bank: $70 billion
  • Morgan Stanley: $60–70 billion
  • Wells Fargo: $75 billion
  • Barclays: $70–80 billion
  • Nomura: $70 billion

 

Investors are even more pessimistic, predicting issuance of $50–60 billion, as investors taking mark-to-market losses get pushed to the sidelines.

The number of managers able to print deals fell to 86 in 2015, from a post-credit-crunch high of 105 last year. Likewise, the number of new CLO 2.0 issuers fell to just six—Z Capital Credit Partners, Doubleline Capital, Loomis Sayles, Wellfleet Credit Partners, Maranon Capital, and Fifth Street Management—from 19 last year and 30 in 2013.

number of 2.0 CLO managers

The most immediate reason for the fall-off in CLO issuance in the second half of 2015 is the sell-off in the secondary market of CLO equity. Indeed, managers say placing new equity has become extremely challenging, especially with BDCs and hedge funds largely on the sidelines as a result of declining NAVs. The average CLO 2.0 equity NAV is currently around 31%, according to BAML. NAVs started the year around 50% and rose to the mid-60s around May.

With the secondary market for CLO equity on its heels—managers report that seasoned 2.0 paper is trading by appointment with some energy-heavy vehicles bid as low as 30–40 while other paper is in a 50–70 context depending the particulars of the portfolio—new-issue equity is being marketed in the 80s, with bids generally inside of that.

Risk retention was also a key factor preventing more managers from tapping the market in 2015, as CLO equity investors are increasingly focused on risk-retention compliant vehicles that offer the option to reprice AAA paper once the typical two-year non-call period expires. Given the wide AAA discount margins at which CLOs are clearing in recent months—generally in a 150–165 context, depending on the gravitas and track record of the manager—this has become a prominent concern.

Even as the manager ranks decline, the pace of U.S. CLO transactions pricing that are structured to comply with U.S. risk-retention regulation when it goes effective next year has risen. That’s perhaps no surprise given the market now less than one year from the Dec. 24, 2016 effective date, but sources also say that pressure from investors to demonstrate compliance makes it difficult to avoid structuring compliant transactions.

As the specter of risk retention approaches, there have been a slew of consolidation deals in 2015 in which large asset managers with the capability to hold 5% of the capital stack acquired boutique loan managers. Such deals include Rothschild’s acquisition of West Gate Horizons; NewStar Financial/Feingold O’Keefe Capital; and Conning/Octagon Credit. In addition, Kramer Van Kirk Credit Strategies formed a strategic partnership with Public Pension Capital (PPC), and Sankaty bought the CLO business from Regiment.

Given that CLOs last quarter made up 60.8% of the demand in the primary institutional loan market, according to LCD, the impact of lower issuance—and consequently lower demand for loans—will be seen next year, although fewer loans are also expected to be issued next year.

Analysts are predicting slightly higher loan issuance in 2016, with estimates ranging from $250–280 billion of institutional loans. Issuance for 2015 is $254.8 billion, according to LCD data, down 31% from the $376.74 billion at this time last year.

State of the primary market

Looking into 2016, conditions are expected to remain tough absent some tightening across liabilities. BB and B spreads hit wides of around 800 bps and 1000 bps respectively after starting the year around 675 bps and 850 bps as investor appetite dried up. Triple A spreads, the largest piece of the CLO structure, are now at 160 bps, similar to levels from the beginning of the year, but wider than lows of 140 bps in the spring.

Investors who had been buying BB and equity as they were falling last year are now unable to purchase more, so it remains to be seen who will step in to take their place.

Managers opening new warehouses in the coming year should be better situated to source new assets, given how loans have sold off in the fourth quarter.

The average bid of the S&P/LSTA U.S. B/BB rated loan index peaked around 98.86 on April 24 and has since declined to 93.78 recently, although the market remains bifurcated between strong and weaker borrowers, according to LCD data. Cheaper asset prices have helped the CLO arbitrage return close to 300 bps, from around 200 bps earlier in the year, according to data from Deutsche Bank analysts.

The improved arbitrage has been driven by widening primary loan spreads, which have risen above 500 bps from a little over 400 bps since July. CLO liability spreads have only risen slightly above 200 bps during that same time period, according to DB. Higher all-in yields of 5.34% on double-B rated loans and 6.12% on single-B rated loans are offsetting the higher liability costs. Those yields were previously around 3.75% and 5%, respectively, at the start of the summer.

Investor demand in 2016
Given the investor base has been taking mark-to-market losses in the mezz and equity tranches, questions remain over how active these investors will be, especially if spreads continue to gap wider to start the year.

This question is especially prevalent for the equity tranches. The mix of an already banged-up investor base that J.P. Morgan analysts have described as “one of [CLO equity investors’] more challenging years in recent memory” and lower-than-expected cash flow going forward is pushing managers to purchase more of their own equity.

Equity holders are also expected to take a cash-flow hit as the spread benefit from the current LIBOR rate to LIBOR floors, usually around 99.7 bps, shrinks. LIBOR usually follows closely after the federal funds rate. The market is currently pricing that the Federal Reserve will bring the fed funds rate above 100 bps by the end of 2016, though changes in inflation projections and growth may slow the pace.

Existing hedge fund investors taking mark-to-market losses on mezz holdings while also dealing with increased AUM redemption requests have stepped out of the market, though other hedge funds, some with freshly minted capital, are expected to fill the void.

Real money investors have consequently been more active lower in the capital structure than usual. Insurance companies, for one, have been purchasing lower investment grade tranches than in the past, rolling down in credit to AA, and in some cases even the BBB, rated classes.

Banks have been getting more active in the AAAs as asset managers, insurance companies, and pension funds have become less so in the second half of the year.

Bank investors, especially those domiciled overseas in Japan, are also important AAA buyers. With LIBOR rising rapidly over the last few months, debt investors should see higher all-in yields once their coupons reset in 2016, according to J.P. Morgan.

CLO AAA tranches will still compete against fixed-rate ABS products like CMBS as a heavy supply calendar in that market and a synchronized sell-off in tandem with other risk assets keeps that asset class competitive.

And for Japanese bank investors, currency considerations also come into play between U.S. CLO AAAs and those being marketed in Europe.

Concerns over losses and downgrades

Although credit concerns at the bottom of the capital structure remain worrisome, CLO investors don’t expect to see a significant rise in defaults or losses at this juncture in the credit cycle just yet, although this may become a more prominent issue in 2017 or 2018.

Leveraged loan default rates are predicted to rise to 3% in 2016, from just under 2% this year, according to LCD’s quarterly buyside survey.

Some investors, anticipating benign levels of defaults, will look to see whether mezzanine spreads and equity prices offer value at current levels. Hedge funds, especially those with freshly raised capital, who are newcomers to the asset class may look to fill the void left by existing hedge fund investors and purchase mezz and equity tranches that have seen mark-to-market losses during this past year.

The lower prices may also be attractive to investors who are willing to provide liquidity and have longer holding periods. BAML analysts noted that of the cash invested into equity tranches, returns are between 18–21%, while Wells Fargo analysts are projecting that cash-flow diversions due to par test failures won’t occur for the next 18–24 months, at least.

Morgan Stanley’s credit analysts have found that, compared to the peak of the previous cycle in 2007, a number of indicators are not as “frothy.” While certain metrics like the significantly higher percentage of covenant-lite loans, leverage levels on loan new issues, and the growth of leveraged debt outstanding are notable; leveraged buyout volumes are lower, interest coverage ratios are higher, and CCC issuance is lower than in the previous cycle.

Risk retention
The countdown continues to Dec. 24, 2016 when risk retention comes online in the U.S. Already the impact has been felt across the market with investors turning up the pressure on managers in 2015 for more details about how they plan to comply with the upcoming regulation.

LCD so far has tracked 26 U.S. CLOs structured to comply with the rule this year, though the actual number of CLOs structured to comply is likely higher as some managers are not yet ready to publicize their retention strategy.

Managers have a number of structure options including the majority-owned affiliate (MOA) and capitalized-manager vehicle (CMV), as well as vertical-slice financing.

These rules may change in 2016, however, if one of two slim outcomes manage to occur. For example, if the Federal Reserve were to allow for the concept of a Qualified CLO, then managers would only need to retain 5% of the equity, assuming the CLO meet certain standardized criteria.

And if the Loan Syndications and Trading Association (LSTA) manages to win its suit against both the Federal Reserve and Securities and Exchange Commission (SEC) over risk retention, the rule could be re-proposed to 5% of the outstanding equity, or even more dramatically, the CLO market would be exempt from current risk retention regulation altogether. — Andrew Park

Follow Andrew on Twitter for CLO market news and insights. 

This story first appeared on www.lcdcomps.com, LCD’s subscription site offering complete news, analysis and data covering the global leveraged loan and high yield bond markets. You can learn more about LCD here

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US CLO Issuance Drops Sharply in 2015, but Posts 2nd-Busiest Year Ever

US CLO volume

It’s easy to forget that 2015 has been the second busiest year for CLO issuance in the U.S., with the current volume total of $97.34 billion behind only the record $124.1 billion from last year.

While activity was brisk in the first half of the year, with volume averaging $9.9 billion a month, the tone was markedly different in the second half as the pace dwindled to $6.3 billion a month. CLO managers and arrangers were confronted with volatile conditions in the second half that required creativity to get these transactions to the finish line.

Predictions for next year, however, aren’t as positive. Weaker demand for mezzanine and equity tranches, concerns over more loans being downgraded to CCC, rising interest rates causing decreased cash flows to equity holders, and challenges from risk retention are all expected to contribute to lower issuance.

CLO market participants foresee a smaller new-issue calendar for 2016, with credit allocation remaining front-and-center as the credit cycle matures. – Sarah Husband


Follow Sarah on Twitter for CLO market news and insight.

Check out LCD for leveraged loan and high yield bond news and data.

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Amid Solid Leveraged Loan Fundamentals, European Managers Expect Sustained CLO Activity

european CLO issuance

Predicting what lies ahead for the European CLO market next year may be tough given the various uncontrollable influences shaping its development – such as regulation, loan supply, and the investor base – but despite a challenging fourth quarter, overall players are constructive about the market’s prospects moving into 2016.

Central to next year’s development is the differing outlooks between Europe and the U.S. from a fundamental credit perspective. This has the potential to play to the European market’s advantage in terms of increasing loan supply as global issuers look to tap into the lower spreads available here versus on U.S loans, and it may also help divert investor dollars away from the U.S. market towards Europe, both at the top of the stack and further down.

At €13.56 billion for the year through Dec. 11, overall European issuance volume in 2015 has not matched previous expectations of €15–25 billion, but a recent trio of pricings has put the total at 93.6% of last year’s €14.49 billion tally, according to LCD. This year’s supply comes from 33 transactions, versus 35 last year, but where this year has outperformed is on the manager side, with LCD counting 23 managers issuing CLOs this year, versus 18 in 2014, and 15 in 2013.

As supply backed up during Q4 this year, numerous managers will now look to price a transaction next year. LCD currently counts 14 managers in its pipeline, and there are many other mandates in the works that are not listed below. That should get 2016 off to a good start, conditions depending, although managers will want to price as early as possible, aware of the supply glut. As a result, supply is set to remain steady next year with forecasts ranging between €13 billion and €20 billion. – Sarah Husband


Follow Sarah on Twitter for CLO market news and insight.

Check out LCD for leveraged loan and high yield bond news and data.