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CLO managers face ramping challenges as inflation risk rises
February 2021 | Issue 231
Hugh Minch
Reporter
A mix of inflation worries and pandemic uncertainty is pushing up loan prices and causing CLO managers to struggle to construct new portfolios, according to market sources. The fears come despite a wave of positive news stories leading to a rally in credit markets since late 2020.
Sources say the policies of the Joe Biden administration in the US, combined with a sweep by Democrats in the US congressional elections, mean the period of ‘easy money’ is likely to continue, raising the risk of inflation. Credit investors are consequently pivoting into floating rate assets.
As a result, the first month of 2021 saw several weeks with record inflows into loan retail funds. The four-day week in the US beginning 18 January saw inflows of $4 billion, the highest since 2016, with more expected in the weeks ahead. The trend has pushed up secondary loan prices with over 50% trading above par, sources say.
“I think you will see the repricing window go on for some time”
Jonathan Moneypenny, Americas co-head of leveraged finance | Credit Suisse
Meanwhile, the continued uncertainty surrounding the coronavirus pandemic and its economic impact means businesses that took on debt in 2020 are cautious about taking additional risks, leading to expectation of a thin M&A pipeline.
Some CLO managers with ramped transactions are said to be waiting for liability spreads to tighten further before they print their deals, while others are opting not to ramp up.
One manager tells Creditflux: “We can’t imagine going out and ramping a new CLO today.”
CLOs have rallied this year, but there is ground to make up on loans. As predominantly floating rate products, however, there is strong chance that investors will flock to CLOs.
But there is pressure on CLO arbitrage because the leveraged loan pipeline is dominated by refinancings and repricings, particularly for loans that were issued in 2020.
“Since there isn’t enough M&A acquisition finance to offset the demand from investors for loans, repricings have begun, and I think you’re going to see the repricing window go on for some time,” says Jonathan Moneypenny, Americas co-head of leveraged finance capital markets at Credit Suisse.
New York-based Moneypenny adds that his outlook for M&A is constructive in the long-term. “We’re optimistic for 2021, and see some return to normality.”
While CLO tranche spreads have lagged the loan market, many of the world’s largest investors are cash-rich and looking to get deals done after sitting out 2020, sources say.
Spread tightening on the liability side should bring the market back to equilibrium, says Credit Suisse’s global head of leveraged and acquisition finance Jeffrey Cohen.
“What we’ve seen historically is that investors who buy the tranches begrudgingly accept the lower spreads to conform to the market, so these big shifts rarely lead to a dislocation,” Cohen says.
The S&P/LSTA leveraged loan index is inching closer to par, with bids averaging 97.59 cents as Creditflux goes to press, up from 96.19 cents on 31 December, and 93.17 cents on 1 November.
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Global credit funds & CLO's
February 2021
| Issue 231
Published in London & New York.
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