Global credit funds & CLO's
November 2023 | Issue 259
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November 2023 | Issue 259
Analysis
CLO census
It’s time to put
the shop in order
Tom Davidson
Managing editor
After a lacklustre year for the CLO market, the 539 respondents to our comprehensive survey are increasingly calling for structural changes, from electronic trading to standardised documents
What kind of market are we in right now? When we ran our Creditflux CLO Census in 2021 the answer was easy. After a banner year, our respondents were in an ebullient mood, with over 80% agreeing that the CLO arbitrage had been great. Their greatest concern was the impending transition from Libor to Sofr.
Last year, global macro-economic challenges plunged leveraged loan markets to stressed levels, and the biggest gripe in our census was that there are not enough investors: 14.4% of respondents called for a broader investor base.
So what does our CLO Census say about market sentiment this year? The answer is more mixed. It hasn’t been a bad year (global issuance stands at $130bn as we go to press), but it hasn’t been a great one. The spectre of recession looms over Europe, and even in the US talk of a soft landing is receding. Both those trends are reflected in the census.
The concerns about the CLO investor base, which were so prevalent last year, have fallen away. Only 6% of respondents chose that option in our freeform question on what they would change about the CLO market.
This result is reflected in our question explicitly asking about our readers’ biggest worries for the year ahead. As usual, we divided these results between four broad types of market participant. Last year, “Lack of investor participation” scored in the 20s for bankers, managers and service providers alike. This time that more than halved, to less than 10% for bankers and services providers, and 12% for managers.
Investors themselves didn’t care either year. Instead they worry about defaults and downgrades in the underlying collateral. This year, those concerns have spread to become the major worry for every segment of the market, albeit with some differences on whether defaults or downgrades are more concerning. Many respondents added an extra nuance to that though, specifying recovery rates in particular as their greatest fear.
New year, old problems
If expanding the investor base has fallen off the market’s wishlist, what replaced it? Three old issues were at the top of our “What would you change in the CLO market?” question: standardising CLO documentation; improving the secondary trading process; and increasing the transparency of almost every aspect of the market.
One US manager explained the need as: “Simplify the new issue process by reducing and/or standardising stips”. That view was shared by another manager, who replied: “Why is the issuance process so hard? We act like a super esoteric asset class despite the size of the CLO market.”
46%
The number of respondents who believe widespread electronic trading of CLOs will arrive sometime after 2026. 15% don’t think it will ever be implemented
The responses in the secondary market fell into two broad camps. Many participants called for improved transparency on secondary trades, from better post-trade colour or even from transaction prices. Another, larger group, focused on the flaws in b-wics, with calls for “more efficient b-wic processes”, “reduced amounts of time spent on b-wics” and “electronic trading please”.
The calls for more transparency also expanded to the underlying loans themselves, with “especially for middle market loans” a frequent qualifier. Respondents also called for warehousing and primary process transparency — and one would like “standardised historical manager performance”.
* Creditflux CLO league tables 2023 Q3 YTD
Will we ever see electronic trading?
We anticipated the calls for changes to the b-wic process with a specific question: “When will we see electronic trading of CLOs?” According to market sources the actual answer is next month, for one or two platforms, so we should perhaps have phrased it as “widespread electronic trading”. Respondents seem to have taken that as the question anyway, with most respondents remaining sceptical. A full 46% of respondents chose 2026 or later.
The frequently discussed topic of the US loan maturity wall seems to be receding though. 58% were only a little worried, with a further 27% unconcerned.
Thoughts on captive equity
The other hot topic this year has been the growth of captive equity funds (vehicles set up to invest in the equity of a single manager). This year, new issuance has been dominated by deals supported by such funds, with more traditional third-party equity funds almost entirely absent.
We wanted to know if this is a good thing. The answer seems to be yes — for most people. 54% chose positive or very positive, compared with just 18% choosing negative or very negative. One respondent summed things up very well: “The growth of captive equity funds is a positive, ensuring more growth in the CLO asset class. But their indiscriminate use, in an environment where arbitrage is lacking, is a negative, creating bad transactions, alienating investors in the long term and drawing regulatory scrutiny.”
We act like a super esoteric asset class despite the size of the CLO market
Middle market for ever
Of course, the burning question of our age is: “Should we call them MM CLOs or PC CLOs?” There has been a trend from certain banks and managers to push for the relabelling of this market. So far it seems that’s still a step too far — 57% of respondents want to stick with MM CLOs. There were also calls for the market to adopt both terms, and a reminder that whatever name is used, this is an area of the asset class that will continue to grow: “PC CLOs are not a fad — they will become a bigger part of the aggregate balance sheet,” said one respondent.
Captive equity funds are a positive — but indiscriminate use creates bad transactions and alienates investors
PC CLOs are not a fad — they will become a bigger part of the aggregate balance sheet
Methodology
- The 2023 CLO Census was an online survey open for two weeks from 5-20 October. We received 539 responses, compared to 389 in 2022.
- We asked respondents to indicate if they were a CLO manager, investor, banker/trader or service provider.
- We vetted responses line-by-line and eliminated cases where companies voted for themselves or for affiliates.
- We would like to thank the CLO community for its support.
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