CLO market finds feet again after ‘miniature credit crunch’ blows up spreads in March

Hugh Minch

Senior Reporter

Markets were rocked by what some observers have called a “miniature credit crunch” in March, with disruption beginning with the collapse of Silicon Valley Bank and ending with UBS’s takeover of Credit Suisse.

CLOs were not exempt, with asset and liability spreads blowing up mid month. But as Creditflux goes to press, the leveraged loan index has recovered most of its value and, while CLO tranches have lagged the recovery, prices are trending higher as the market rediscovers its balance.

Meanwhile, the primary issuance pause that often follows macro disruptions was brief, with new CLOs forming after a gap of just five business days.

Erik Miller, who co-heads the CLO operation at Canyon Partners, describes his approach to the CLO market during March’s turbulence as “tepid conviction”.

“The market moved so rapidly that an exhale would not be surprising,” Miller says, describing the move tighter in credit spreads after the initial spike in mid-March.

“Over the next 12 months, there are some supportive trends on the CLO liability side that suggest stability and probably modest tightening.”

Capital flows in the US banking sector continued to draw headlines going into April.

“The market moved so rapidly that an exhale would not be surprising”

Erik Miller, Co-head of CLOs | Canyon Partners

BofA found that small banks saw $107 billion withdrawn between 8 and 15 March, while larger banks saw deposits increase by $120 billion during the same period.

Meanwhile, BofA sees benefits to CLOs resulting from a change in interest policy from the Federal Reserve.

“CLOs get bailed out by bank pressure as the Fed is forced to stop hiking further to prevent bank distress,” wrote BofA analysts Pratik Gupta, Chris Flanagan and Victoria Xu in April. “This likely stops further pressure in interest coverage ratios. However there will be second-order and third-order effects as bank lending activity sees a slowdown.”

Canyon’s Miller says the volatility is likely to have a “filtering effect” on manager tiering, which will lead to consolidation within the CLO manager base.

“The choppy market has had a filtering effect on tiering managers because small managers have a shallower debt following and less committed equity, so the threshold of getting a transaction done is higher,” Miller says. “The market share of established managers has expanded in the first months of 2023.”

US CLO issuance volumes were $7.74 billion in March.

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Global credit funds & CLO's

April 2023 | Issue 253

Published in London & New York.