Banks cut CLO forecasts as spreads hit two-year high

Banks are cutting Collateralized Loan Obligation (CLO) issuance forecasts after spreads on the most senior tranches of the funds hit a more than two-year high, challenging the creation of new deals. Barclays last week cut its forecast for US CLO refinancings and resets to US$40bn-US$55bn from US$95bn-US$110bn, while Wells Fargo this week revised its CLO forecast for refinancings and resets to US$45bn from US$100bn, according to research reports.
US CLO issuance this year has been challenged as spreads on Triple A tranches, the largest and most senior piece of the funds, have continued to widen after a record US$128.1bn of US CLOs was arranged in 2018, overheating the market. A pullback by some investors as the Federal Reserve (Fed) stopped raising rates has also weighed on the asset class. The average US CLO Triple A spread was 138bp over Libor in February, the highest level since January 2017, when the average senior piece was about 145bp, according to LPC Collateral data.
More than US$25bn of US CLOs have been arranged this year through March 27, down from US$29.2bn during the same period in 2018, as issuance has come in spurts, according to the data. "The widening of CLO Triple A spreads can be attributed to several reasons, including the (lower) appeal of floating-rate instruments due to (the) Fed's pivot, the large supply, and investors' concern of corporate sector fundamentals and recession risk," said Tracy Chen, head of structured credit at Brandywine Global Investment Management.
CLOs are the biggest buyers in the US$1.2trn US leveraged loan market. Investors have been attracted to the floating-rate nature of loans and CLOs - both products typically pay a set coupon plus Libor, so as rates rise, so do investor payments. The Fed hiked rates nine times between 2015 and the end of 2018. But as the Fed halted its rate-hike run late last year, and told investors this month that it does not foresee any increases in 2019, that pitch of rising payments has lost its luster. Investors have pulled more than US$9.5bn from loan funds this year through March 27, according to Lipper.
JP Morgan revised its new-issue US CLO forecast in February, calling for US$115bn-US$125bn of volume this year. It had originally predicted US$135bn. "Our forecast still implies a busy year as US$120bn would be the third-highest annual tally, if realized," the JP Morgan CLO analysts wrote in a February 22 report.