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CLO market thrives despite loan shortage, but ageing warehouses cause concern
by Paul Conley
The CLO market appears to be defying gravity. New issuance is booming despite a dearth of the loans necessary for CLO creation. But warehouses are signalling that not all is well.
An increasing number of ageing warehouses are present in the market, according to CLO managers and bank data. This underscores the challenges of putting together a CLO in today’s environment. Many managers are struggling to find enough collateral to ramp up a deal amid a drought in new leveraged loan supply.
Recent US Bank data shows there were 85 deals in warehouses that the bank tracks at the end of May of this year. Of them, 29 — more than a third — have been in warehouses for longer than 270 days.
“We’ve noticed some longer warehouse periods, but at the same time, for the most part, warehouses have been very lightly ramped,” said Komal Shahzad, senior vice president, CLO investing at PineBridge Investments.
For the most part, warehouses have been very lightly ramped
Komal Shahzad
Senior vice president, CLO investing
PineBridge
Warehouses, which are credit lines that managers use to purchase loans, typically run for six to 12 months. There is a danger in a deal that languishes longer. If a warehouse sits open for more than 12 months, banks can freeze the assets and require managers to add more equity.
In addition, there is a market risk. If bond prices change dramatically during a long warehouse period, it makes pricing the CLO difficult. When bank loans drop in value after they have been purchased, and before a CLO launches, the warehouse is said to be “underwater”. CLO investors often baulk at investing in CLOs with underwater warehouses. This happened in the latter half of 2022 when the Fed raised interest rates to fight inflation. Loan prices fell and large numbers of CLO managers found themselves underwater.
The backlog of older warehouses may soon grow worse. At the end of May, 10 deals had sat in warehouses for 181-270 days. A year earlier, there were only six, while six deals had been in warehouses for 121-180 days. This year the 121-180 day number has risen to nine.
“The true loan pipeline, outside of refi deals, has been very light,” said Shahzad. “And most of the secondary market is above par and that price is not ideal from a CLO equity arb perspective.”
It’s a sentiment echoed by another CLO manager. “We have some warehouses open. But a lot of loans are trading at premium levels and trading above par, and those levels don’t really work for a new CLO,” the manager said.
“It’s not like we can easily go out and find a lot of loans at prices we like on loans that we like. That opportunity doesn’t exist for us right now. And I’m pretty sure it doesn’t exist for anyone else.”
Data from Debtwire shows just how barren the new-money cupboard is. Year-to-date, the market has seen USD 643bn in refinancings. That dwarfs the USD 70bn in new money issuance. A year ago, things weren’t any better. Refinancings in the first half of 2023 stood at USD 110tn, while new money reached USD 35bn.
A look back to 2022 shows how much things have changed. The first half of that year saw USD 1.27tn in new money and just USD 73bn in refi deals.
Edwin Wilches, managing director and co-head of securitised products at PGIM Fixed Income, said it isn’t the lack of loans but the attractive nature of refis and resets in today’s market that’s requiring managers to pick their shots and leave deals sitting in warehouses longer.
Still, everyone in the CLO space would like to see more leveraged loan supply, acknowledged Wilches. Especially the smaller shops.
“I think for the largest managers, their access to collateral is not as challenging as much as it is for small managers. I think they all want more primary, but it hasn’t slowed down CLO issuance,” Wilches said.
