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AAA CLO Spreads Continue to Rise Amid Supply Surge

AAA spreads

After tightening below the psychological 100 bps mark earlier this year, AAA spreads of five-year reinvestment period CLOs have been widening since March due to a heavy supply of both new issue CLOs and reset of existing deals, according LCD.

AAA spreads, which make up about 60% of a CLO’s total financing costs, touched a post-crisis low of 93 bps in March. They averaged 98.47 bps over the month, before a pickup in resets and an active new-issue pipeline increased average spreads to 102.53 bps in April and to 108.06 bps in May.

CLOs – collateralized obligation vehicles – are special-purpose finance vehicles set up to hold and manage pools of leveraged loans. The vehicles are financed with several tranches of debt (typically starting with a triple-A rated tranche, then proceeding down the ratings ladder, to subordinated debt) that have rights to the collateral and payment stream, in descending order.

They are a critical part of the leveraged loan investor universe, and their issuance has boomed over the past few years as cash-rich institutional investors struggle to find higher-yielding investments.

From an LCD News story by Andrew Park. Follow Andrew on Twitter.

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Europe’s CLO Market, Already Red-Hot, Looks to Go Green

The world’s first green CLO is on its way amid a growing sustainable finance market and a push from regulators to scale up green investments to tackle climate change.

While the private sector has already been developing markets for green assets, such as green bonds and loans, increased global regulatory coordination is in the offing to support further growth of green financing, in particular the creation of a sustainable securitisation market.

One European manager, which focuses exclusively on investment in clean energy infrastructure, is working on the first green CLO, according to sources. It will also be the manager’s first CLO issue.

global CLO 1Permira Debt Managers took an initial step in March towards creating a sustainable CLO market by making its €362.5 million Providus I vehicle compliant with environmental, social, and governance (ESG) criteria. The manager’s future CLOs are also going to be ESG compliant, sources say.

ESG criteria calls for socially responsible investments and prevents a fund from investing in certain industries (such as speculative extraction of oil and gas, weapons and firearms, tobacco, gambling, and payday lending, among others).

A green CLO focuses on the “E” in ESG. Sources say the upcoming vehicle will invest solely in green sectors and projects that have a positive and so-called “global cooling” environmental impact, such as renewable energy and energy efficient transportation.

A revolution
Sustainable (or green) CLOs, along with other sustainable structured products “are set to turbocharge sustainable finance,” wrote White & Case partners Chris McGarry and Debashis Dey and counsel Mindy Hauman in a client alert in May. “CLOs will be a pillar of the sustainable securitisation revolution,” they added.

The green finance market is still at a nascent stage, but it’s growing rapidly and will benefit from certain accords. Indeed, to reduce climate risk in line with the Paris Agreement, the United Nations estimates that $90 trillion of investments are needed in the next 15 years to build out sustainable infrastructures that include everything from energy to public transport, buildings, water supply, sanitation, and so on. The Organisation for Economic Co-operation and Development (OECD) estimates annual issuance of sustainable asset-backed securities (ABS) could reach $350 billion by 2035 and notes that it is the fastest growing product under the sustainable finance umbrella.

Other forms of sustainable securitisations include ABS made up of sustainable auto loans, solar loans, and Property Assessed Clean Energy (PACE) loans, as well as mortgage-backed securities for green residential and commercial properties.

“We are pushing hard for green securitizations because the scale of investments around the world to achieve low carbon is so vast that the balance sheets of banks are not going to be able to cope, especially as the banks need to recapitalize,” says Sean Kidney, CEO of the Climate Bonds Initiative (CBI), an organization which aims to develop a liquid green and climate bond market and which partners with banks, bond issuers, institutional investors, law firms as well as ratings agencies and other institutions.

Global issuance of green bonds totaled $160.2 billion in 2017, up 85% versus 2016. The CBI forecast for 2018 calls for the global green bond market to grow to $250–300 billion. The U.S., China, and France accounted for 56% of 2017 issuance. U.S. government agency Fannie Mae was the largest issuer of Green MBS in 2017 at $24.9 billion.

Some existing CLO managers are somewhat skeptical about the green securitisation market though, given that it remains relatively niche, but they say the theme is becoming more and more topical.

“We haven’t written ESG criteria into our CLO documentation, but we have ESG watch flags in our investment processes. Lots of institutional investors are stressing the importance of it, but it needs to be clear that this should not only be a marketing strategy to boost reputation,” says one CLO fund manager.

It is not just specialist investors, but also global managers that follow sustainable investment strategies. “Asset managers like Amundi and BlackRock, but also several commercial banks’ treasuries invest in green bonds,” says Tanguy Claquin, head of sustainable banking at Credit Agricole CIB, which ranked as the top arranger of green financing in 2017, according to various league tables. Claquin also sees large potential for growth in the green securitisation market.

Definition
A lack of clarity remains around the definition of green/sustainability. The two phrases are often used interchangeably for investments that have a positive environmental impact.

So far there is no universal agreement on a definition. “Should nuclear energy be considered green? Given the diversity of opinions, it can be challenging to establish ‘standard’ definitions of green,” according to a report on green bonds published last December by The World Bank, Zurich Pension Fund, Amundi Asset Management, and Actiam.

A number of initiatives have been put forth though to set standards. In March, the Loan Market Association launched the Green Loan Principles (GLP) to help growth of the global green loan market. The GLP builds upon the Green Bond Principles (GBP) of the International Capital Market Association (ICMA) and sets voluntary guidelines to promote transparency and disclosure, along with second-party opinions. S&P Global Ratings has the Green Bond Evaluation service, while Moody’s provides the Green Bond Assessment. CBI also provides an extensive taxonomy and certification for green bonds.

global CLO 2While certifications can create extra costs and operational efforts, fund managers like them as they help with due diligence processes to assess a bond’s use of proceeds. “We and our clients want a lot of transparency so that we know how the proceeds are spent, even for future projects that an issuer—at the time of raising a green bond—has not yet selected. We want to make sure we know how the money really is spent,” says Foppe-Jan van der Meij, portfolio manager at Actiam, a €54 billion-plus Netherlands-based fund manager that complies with the Green Bond Principles for investing in green bonds as well as ABS.

The firm‘s investors are insurance companies, pension funds, and wholesale distribution partners like banks. “We are seeing a lot of demand. More and more investors are incorporating green goals and ESG criteria into their strategies. Retail investors are very keen to put money to work towards green bond funds. Returns are in line with non-green bonds, but their [secondary market] performance in a volatile market is more stable,” van der Meij adds.

CBI’s Sean Kidney also notes that while there is growing demand for green bonds, they pay similar spreads to comparable non-green bonds with the same tenor and currency and rating. “Investors don’t do it for the price benefit, they do it for the diversification benefit,” he says.

Asset sourcing
Sourcing enough assets to fill a green fund though is one major challenge for investors, they say, because the number of issuers active in the green bond market is still limited. Actiam said that for its mainstream €3 billion fund, 10% is invested in green bonds, including sovereign and corporates, while the remainder is invested in conventional bonds, although those still need to meet a minimum proprietary ESG score that is better than the benchmark.

White & Case argues this issue can be overcome, saying that there is a critical mass of assets available. “It is just a question of market education and re-examining potentially eligible assets for sustainability,” the law firm wrote in its May client briefing. Moreover, it adds that sustainable securitisations will help free up bank’s balance sheets, enabling them to arrange more deals.

For example, Credit Agricole last year transferred the risk of $3 billion-worth of project finance loans to Mariner Investment via a so-called green capital note (Premium Green 2017-2). As part of the transaction, it committed to use $2 billion of the $3 billion of freed-up capital for new lending in green sectors, such as renewable energy and energy-efficiency loans for commercial real estate and public transportation, among others.

This creates a “sustainable finance loop” that generates more assets on a rolling basis, White & Case says.

Regulatory landscape
The regulatory landscape is also starting to become more supportive of green investment, with a long list of legislative initiatives on the way to help drive investments. For example, under the simple, transparent, and standardised (STS) framework of European securitisation regulation, sponsors and originators will be required from January 2019 forward to disclose information on the energy efficiency of underlying assets in RMBS and auto loan securitisations in order to receive beneficial regulatory capital treatment.

The European Commission has also set up a “High Level Expert Group on Sustainable Finance” to address funding shortfalls and create plans for sustainable finance as part of the European Capital Markets Union. In its action plan published in March, the EC said it would establish a unified EU classification system or taxonomy to define sustainable investments, identify areas where sustainable investments can make the biggest impact, and clarify the duty of asset managers and institutional investors to take sustainability into account in the investment process and enhance disclosure requirements.

On a global level, the Bank of England and the People’s Bank of China as co-chairs of the G20 Sustainable Finance Study Group (SFSG) are currently developing plans to mobilize private capital for green investment, according to SFSG reports. This includes further research into the securitisation of sustainable assets, as approved in a meeting in February. The SFSG will hold its second meeting in early June and then submit a new report to the G20 Finance Ministers and Central Bank Governors Meeting in July and the G20 Leaders’ Summit in December. — Isabell Witt

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Octagon prices $611M Vehicle; YTD US CLO Issuance Tops $53B

Citi yesterday priced a $610.9 million CLO for Octagon Credit Investors LLC, according to market sources. This is the manager’s third new issue of the year.

Pricing details are as follows:

The transaction will close on July 10, with the non-call period running until July 2020, and the reinvestment period ending on July 2023. The legal final maturity is on July 2030.

Year-to-date new issuance in the U.S. is now $53.77 billion from 95 CLOs, according to LCD data. May’s volume is now $10.82 billion from 20 new issues. — Andrew Park

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It’s Official: US Leveraged Loans Are a $1 Trillion Market

index trillion

It’s official: The U.S. leveraged loan market is a $1 trillion asset class.

As of April 27, the amount of outstanding institutional credits underlying the S&P/LSTA Index topped that milestone, after growing uninterrupted every year since hitting a post-crisis low of $497 billion in 2010. It has since doubled to its current size.

Another milestone: The loan market comprises more than 1,000 issuers (1,025 to be exact), up 56% from the 658 at the end of 2010.

These two headline numbers are only the latest highlights for a market that has been running at breakneck speed over the last two years.

In 2017 the U.S. loan market printed a record $503 billion of institutional loans, exceeding by 10% the prior high of $455 billion in 2013, according to LCD. While last year’s super-charged conditions contributed to the growth of the Index, however, they did not push it across the $1 trillion mark because 48% of 2017 issuance backed refinancings and recaps. On a net basis, the Index grew by $75 billion last year, roughly half of the $131 billion expansion in 2013.

The growth in the U.S. leveraged loan market over the past few years has coincided with increased interest in the asset class from retail investors into loan mutual funds/ETFs, and via the formation of collateralized obligation vehicles (CLOs), which buy portions of large corporate loans.

One reason for the increased enthusiasm from investors is interest rate hikes by the Fed. Floating-rate assets, such as loans, tend to fare better in a rising-rate environment than do fixed-rate assets, such as high yield bonds.

CLO issuance in 2017 totaled $118 billion, easily outstripping projections made at the start of the year and nearing the record $124 billion in 2014, according to LCD. And CLO investors have only picked up the pace this year; so far in 2018 there has been $40.3 billion of new CLOs issued, compared to $25.2 billion during the same period in 2017. – Staff reports

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Amid High-Yield Market Flight, US CLO Parade Marches On

Investors continued to flock to the leveraged loan asset class in March, with a steadily rising base rate – LIBOR – and expectations of additional Fed rate hikes in 2018 drawing ever-more cash into the floating rate environment.

One of the biggest sources of demand for leveraged loans – collateralized loan obligations – just wrapped up another banner quarter, with $32.1 billion of new CLOs issued, according to LCD. That’s nearly twice the amount seen during the same period a year ago. During all of 2017, U.S. CLO issuance totaled an impressive $118 billion, easily surpassing expectations at the start of the year and nearing the record $124 billion in 2014.

One reason the leveraged loan market is seeing sustained institutional investor interest now: three-month LIBOR, the rate on which these credits traditionally have been based, has risen some 62 bps since the start of year, buoying yields in the segment, even as the spread over LIBOR has decreased, due to the amount of cash flooding into the market. (Issuers today also can have the option to switch to one-month LIBOR, which has risen less markedly than the three-month rate.)

Indeed, while U.S. loan funds and ETFs have seen a net inflow of roughly $3 billion in 2018, investors have withdrawn roughly $15.5 billion from high yield bond funds this year, according to Lipper. High yield bonds, of course, over investors a fixed rate of return, as opposed to leveraged loans, which are priced at a spread over LIBOR.

CLOs are special-purpose vehicles set up to hold and manage pools of leveraged loans. Since the financial crisis their prominence in the U.S. leveraged loan market has grown, with CLOs accounting for roughly 65% of all loans syndicated during 2018’s first quarter, according to LCD.

At the end of March U.S. leveraged loan market outstandings totaled $994 billion, according to the S&P/LSTA Loan Index. – Tim Cross

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European CLO Issuance Sees Record First Quarter

european CLO issuance

CLO issuance in Europe for the quarter through March 20 is €5.45 billion, and with a further two transactions likely to close out before quarter-end, 1Q18 would be the busiest first quarter of a year ever for this market, according to LCD.

It would also be the second-largest quarterly new-issue volume in the post-financial crisis “CLO 2.0 era” (the largest such tally is €7.7 billion, recorded in 4Q17).

These are important numbers for the leveraged loan asset class, as CLOs comprise a critical part of the investor base, in both Europe and U.S., often driving activity in that sector.

Of course, as more investors pile into the global CLO market – eyeing what historically have been relatively rich returns – spreads on these deals have dwindled, often testing record lows throughout 2017, and into 2018. – Staff reports

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CLO Issuance Eases in January After Stellar 2017

US CLO issuance

The U.S. CLO market, which finished 2017 on a surprisingly strong note, downshifted in January, though issuance in the segment easily topped that seen in the year-ago period.

There were $6.34 billion of collateralized loan obligations vehicles last month, less than any month in 2017 – except the $980 million in January. Issuance for all of 2017 totaled $117.75 billion, according to LCD.

That number was surprising, with some market expectations at the start of 2017 at roughly half that amount, as the U.S. CLO market entered its first full year under the risk-retention requirement, courtesy Dodd-Frank. That rule mandated that CLO managers retain at least 5% of their CLO vehicles, as opposed to selling them off in their entirety.

As opposed to hindering the market, however, CLO issuance took off, including some $7 billion issued specifically with risk-retention in mind, according to industry estimates.

CLO issuance in 2018 is expected at broadly the same levels as in 2017, according to LCD’s Andrew Park.

CLOs are a crucial part of the leveraged loan investor base, as they comprise roughly 60% of deals brought to the U.S. syndications market, according to LCD. Right now, there is roughly $970 million outstanding in the U.S. leveraged loan market, according to the S&P/LSTA Index. – Tim Cross

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Surpassing expectations, 2017 US CLO Issuance Nears Record Levels

Issuance of collateralized loan obligation vehicles in the U.S. topped $118 billion in 2017, according to LCD, easily topping market expectations at the beginning of the year.

Indeed, due to risk retention guidelines enacted via Dodd-Frank – which mandated that CLO managers retain at least 5% of a CLO, as opposed to selling off the entirety of the vehicle to investors – the market consensus had CLO issuance slumping dramatically last year, to $55-60 billion, by some estimates.

That proved not to be the case, however, as the relatively attractive returns provided by CLOs in the current yield-starved capital markets was attractive to investors. In fact, during 2017 there was roughly $7 billion in CLO issuance created specifically with risk-retention in mind, according to market estimates.

CLOs comprise roughly 60% of the U.S. leveraged loan investor base. At year-end, there was some $960 billion of U.S. leveraged loans outstanding, according to the S&P/LSTA Index. – Staff reports

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Led by CLOs, Institutional Investors Grab Unprecedented Share of 2017 Leveraged Loan Market

Propelled by first-half cash inflows into loan funds and surprisingly robust CLO issuance throughout the year, institutional investors grabbed an unprecedented share of the U.S. leveraged loan market in 2017. All told, institutions accounted for 90% of primary allocations this year—excluding those taken by deal arrangers—up from 88% in 2016, according to LCD. The institutional investor dominance was consistent in 2017, ranging from 89% of allocations in the first quarter to nearly 94% in the fourth.

Quarterly CLO Volume 2017

One thing that drove institutional investor market dominance this year: U.S. CLO issuance has topped even the most optimistic predictions made at the beginning of 2017, when the specter of risk retention hung heavily over the market. In the year to date, $115.9 billion of CLO vehicles have priced (including $33.8 billion in the fourth quarter), easily topping the $72.3 billion full-year total in 2016.

Of course, as CLO issuance remains in high gear, that investor component gobbles up market share. So far this year, CLOs account for 64% of institutional loan allocations, up from 62% in 2016 and from 50% in the wake of the financial crisis in 2009.

CLO Share of Institutional Market

What’s more, as the segment continues to heat up and investors get more comfortable around the CLO asset class, the market for U.S. CLOs has expanded from a clubby group of asset managers, hedge funds, and banks to now include insurance companies and pension funds across the U.S., China, Korea, Japan, and Australia. — Staff reports

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Ellington Prices $453M Vehicle, Capping Off – Maybe – Suprising Year for US CLO Market

Citi today priced a $452.8 million CLO for Ellington CLO Management, according to market sources. This is the second CLO to be issued from the manager, which debuted in April.

The manager is retaining a horizontal slice to comply with risk retention in the U.S.

Pricing details are as follows:

Ellington_CLO_2017-12-18

The transaction will close on Jan. 30, with the non-call period running until Feb. 15, 2020, and the reinvestment period ending on Feb. 15, 2021. The legal final maturity is on Feb. 15, 2029.

Year-to-date new issuance is now $116.35 billion from 208 CLOs, according to LCD data. New issuance in December is now $8.14 billion from 16 transactions. — Andrew Park

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