In 2018, collateralized loan obligation (CLO) spreads hit multi-year tights in February and remained relatively tight until November and December’s nasty bout of volatility. This environment of tight spreads proved to be a benefit for CLO issuers and equityholders. For those looking to either issue new deals or refinance existing deals in order to achieve a lower cost of debt, these conditions contributed to record deal volume for the sector last year. As existing deals arose for refinancing or a reset (refinancing with an extension), investors were faced with the decision on whether to roll into the new deals or not. With such a rapid pace of refinancings and resets, CLO investors were forced to remain active as they reinvested redeemed proceeds in order to maintain CLO exposures in their accounts.
The volatility that beset the markets starting in November 2018, however, changed the landscape of the CLO trade in a material way. Spreads are softer now, and it remains a buyer’s market in many respects. With fewer resets coming through compared to last year, investors are engaged in a much lower amount of reinvesting, and it remains easier for investors to stay fully allocated in the space. Indeed, some expected lower issuance this year to create some scarcity value in the sector on the supply side, but the demand has shifted lower as well. Many investors are fully invested in CLO and not looking to add as much as they did last year.
While soft spreads will continue to dampen resets that close in the near future, regular way issuance (deals with fresh collateral and structure) is really just a stone’s throw away from last year’s levels. New CLO managers continue to enter the space, in spite of a less than exhilarating arbitrage (CLO income on underlying assets minus the CLO cost of debt). Even if their early deals offer inadequate excess spread, these new managers continue to see opportunity in growing a CLO platform and getting fees in the door. Pipelines remain healthy and the CLO machine continues to hum along, albeit at a slower rate than last year.
The CLO machine is slowing down compared to 2018, but it is not in danger of stopping. New issuers continue to enter the space, and regular way new issuance is not too far off from what it was last year. Soft spreads will continue to put a damper on reset volume; however, many investors are now fully invested in CLO. This has led to lower demand offsetting the lower supply the market has seen year-over-year.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
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