(Adds newly priced CLOs in the seventh paragraph)
LONDON, March 12 (LPC) - Increasingly risk adverse investors to CLOs are selling out of their positions amid mounting fears of a spread of coronavirus and a sharp decline in oil prices that is expected to delay the issuance of new CLO vehicles.
A number of CLO investors, from the senior Triple A tranches all the way through to the deeply subordinated equity holders, are considering options to sell their positions as secondary market activity picks up pace.
Offers for secondary CLO paper are higher than what can be achieved on primary issuance, attracting buyers.
“We see forced sellers in the market for the Triple A tranche in the US and we certainly see that in Europe they have been trading significantly wider in the secondary,” said Laila Kollmorgen, managing director at PineBridge Investments in Los Angeles who manages CLOs in both Europe and the US markets.
“That could slow down the issuance in the primary market.”
European Triple A tranches are trading at approximately 150bp-160bp in the secondary market, much wider than 120bp guidance for new transactions and an average 92.8bp for the printed CLOs in the first two months of 2020.
The spreads for new Triple As have already been widening with Credit Suisse Asset Manager’s Madison Park Euro Funding XV pricing at 120bp over Euribor this week, following PGIM’s Dryden at 100bp earlier this month.
“It’s a matter of if we are able to get some levels of stability in the coming weeks, but that’s really an unknown,” Kollmorgen said.
Kartesia, a European direct lender that also invests in CLOs, has just bought a €25m equity tranche of a CLO from another investor.
“The market is in disorder because of the coronavirus shock,” said Jaime Prieto, managing partner at Kartesia.
“Although the final fundamental impact of coronavirus will be greater than what many envisage, the technical dislocations may offer a good opportunity with strong downside, and attractive upside optionality.”
As market volatility increases, pricing has compressed on the equity tranches of CLOs to around 60% of face value, compared to 77% a week ago.
As such, demand for primary CLOs will inevitably be affected, sources said.
“Offers in secondary are competing with primary deals that may find it difficult to raise financing in the short term, both factors should lead to a slow down of the CLO issuance,” Prieto said.
It comes after a post-crisis record year of issuance in 2019, with volume of €29.8bn, according to LPC data.
2020 kicked off with high expectations following the UK general election and more certainty in terms of Brexit. Eleven European CLOs totalling €4.6bn were printed in the first two months of the year, 3.3% higher than the same period a year ago.
However, CLO issuance is expected to be down year-on-year given the CLO sell-off and the difficulty managers and banks will have in sourcing paper to fill up the CLOs with. Volume in Europe’s syndicated loan market is expected to be significantly lower as deals are cancelled or delayed.
“The thing to watch is if warehouses go into liquidation or if there are large redemptions in funds. If that is the case, the secondary market in leveraged loans will crater,” a senior banker said.
CLOs, which are the biggest buyers of leveraged loans, package the product into different slices of risks to sell to investors as bonds with varying yields. The highest-rated tranche holders get paid back first, while equity, the most junior tranche is more exposed to loss.
Market volatility is a test to a CLO managers’ capability to prevent their equity holders taking a hit.
“CLO managers who show value-add in credit selection and loans trading will stand out and bring attractive returns to the equity tranche holders,” said Kollmorgen. (Editing by Claire Ruckin and Chris Mangham)