Financial Affairs

CLO issuance increases slightly in the second quarter against a backdrop of deteriorating lending

NEW YORK (LPC) – The issuance of secured loan bonds (CLOs) in the United States edged up in the second quarter amid worsening fund loan holdings caused by the coronavirus pandemic, putting the market under pressure.

According to data from LPC Collateral, US $ 18.1 billion of US CLOs have been arranged in the past three months, up from US $ 15.7 billion in the first quarter. After issuance fell to $ 3.4 billion in March, the lowest monthly tally since January 2017, the asset class has come back to life and $ 8.2 billion in deals were valued in June.

The $ 693 billion US CLO market is the largest buyer of US leveraged loans. A healthy CLO market can support mergers and acquisitions and support day-to-day business operations. But as the coronavirus pandemic swept the world, shutting down supply chains and drying up consumer demand amid government-ordered shutdowns, many businesses that rely on the leveraged loan market have seen a downturn in their activities.

Credit rating agencies have responded by downgrading a significant number of borrowers, putting pressure on CLOs who can only hold a limited number of low-rating loans before they trigger tests that may eventually halt loans. payments to fund investors.

“It has been a bit of a roller coaster ride with the March liquidity drop and the loans really driving the CLOs down throughout the period where you saw a good retracement return to pre-Covid levels,” a said Chris Long, chief executive officer of asset manager Palmer Square Capital Management.

The CLO market opened in January with $ 4.07 billion in issuance, followed by $ 8.25 billion in February, with companies taking advantage of a borrower-friendly market to reduce interest payments. More than $ 126 billion in U.S. institutional loans were refinanced in the first quarter, according to data from Refinitiv LPC.

But as the coronavirus began to spread around the world, market volatility hit CLO and loan asset classes.

CLO tranche spreads widened as leveraged loan prices fell to their lowest level in nearly 11 years. The LPC 100, a cohort of America’s 100 most liquid loans, has fallen more than 21% year-to-date to 77.87 cents to the dollar on March 23. It stood at 93.6 on Friday.

Volume began to recover in the second quarter with $ 3.9 billion of CLOs issued in April, nearly $ 6 billion in May and $ 8.2 billion in June.

“The issuance of CLO resumed in April / May as liability spreads recovered and investor confidence returned to some extent,” said Rishad Ahluwalia, head of CLO research at JP Morgan based at London.

In the second half of the year, Rachel Russell, head of the CLO syndicate at Morgan Stanley in New York, expects spreads to tighten, especially on the senior tranche.

“Real money investors are enjoying the credit enhancement within Triple As and the volatility over the past few months illustrates the structural protections built into CLOs,” she said.

Certain senior tranches of CLO were listed below 170bp in June, according to LPC Collateral.

DEBT DEGRADATION

In response to the pressure on businesses following the pandemic, rating agencies have downgraded a significant number of businesses whose loans are held by CLOs. In turn, the classifications of the vehicle units were reviewed.

S&P Global Ratings has placed approximately 13.9% of its outstanding US CLO ratings on watch with negative implications. At the same time, more than 1,000 classes of US CLO tranches are being considered for downgrade by Moody’s Investors Service.

The downgrades have forced investment firms to be nimble in responding to market conditions.

“When I look at everything we’ve been through, the events of the first half of the year highlight one of the main characteristics of CLOs: they are actively managed vehicles,” said Russell. “This will be an opportunity for CLO managers to differentiate themselves, through credit selection, trading decisions and portfolio management.”

As the market has stabilized, many participants are more optimistic.

In late June, Wells Fargo raised its U.S. CLO issuance forecast for 2020 to $ 65 billion, from a revised forecast of $ 50 billion on May 4. Its initial forecast for 2020 was US $ 90 billion.

But questions about the economy in the broad sense and the health crisis continue to weigh on managers.

“As for the levers under our control – the quality, duration, diversification of issuers – we keep them on the more conservative end,” Long said. “It’s like dealing with unknown unknowns. This is quite a challenge for a CLO manager.

Reporting by Kristen Haunss; Editing by Michelle Sierra