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March 2021 | Issue 232
European CLO and loan spreads jostle in tight race
Michelle D'Souza headshot
Michelle D’souza
New issue CLO spreads have tightened so sharply in Europe that market participants are questioning how long the process can continue.
European CLO triple A spreads averaged around 106 basis points in December, down from 148bp in July and highs of 225bp in April. By January, spreads fell to an average 86bp, according to Creditflux data, with KKR setting 83bp tights on 29 January. And spreads squeezed further in February as Permira Debt Managers set an 80bp benchmark with Providus CLO V.
“It’s a full-on flat race between triple As and loan spreads,” says Graham Rainbow, co-chief investment officer of liquid credit and head of European loans at Alcentra.
CLOs need a roughly 200-basis points differential between the two to make the arbitrage work. The weighted average cost of capital is around 164 basis points, according to Creditflux data, which means loan spreads should ideally be 360bp. “It’s the race to tighten and whether that happens in the right proportion,” says Rainbow. “If the CLO liability stack does not continue to tighten, you only need another 15bp off the loan spreads and the arb starts to suffer.”
“It’s a full-on flat race between triple As and loan spreads”
Graham Rainbow, Co-chief investment officer of liquid credit | Alcentra
He says that capacity is a factor: how much room do triple A investors have to keep accepting tighter spreads and how much loan supply filters through.
New issue January loan spreads in Europe were averaging 397bp at an average price of 99.4, says one CLO manager. But some new issues in February are coming at 350bp for a mid-single B, down from around 400-425bp last year. If spreads tighten to 300-325bp without the triple As coming in significantly, there will be pressure on CLO economics.
While European primary loan new issuance has been healthy coming into 2021, sources say the pace needs to pick up soon in order feed the CLO machine that has been put on an accelerator.
Lucy Panter, portfolio manager and partner at Oak Hill Advisors, said at Creditflux’s CLO outlook webinar that one caveat to the healthy issuance is that the market is losing some big leveraged loan names, which are either going to special purpose acquisition companies (Paysafe) or non-levered buyers (Refinitiv).
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Global credit funds & CLO's
March 2021
| Issue 232
Published in London & New York.
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