Low warehouse balances show CLOs bracing for volatility

Hugh Minch

Senior reporter

A record number of CLO warehouses are open but contain record low balances, according to several market sources. The figures indicate that CLO managers and equity investors are preparing for a sell-off in the loan market in the latter half of 2023.

“A lot of equity investors are playing the option to buy the dip, and are not committing themselves to executing in this market given the state of the arbitrage,” says Michael Herzig, senior managing director and head of business development at First Eagle Alternative Credit. “They must be expecting loans to dip because if they were waiting for triple As to tighten they would still be buying loans now.”

The lack of new issue loan supply is contributing to the low balances in CLO warehouses, since historically managers have used their warehouses to access the primary market. One speaker at the LSTA and Dealscribe’s CLO conference in New York this May, who represents a CLO arranger, said the typical CLO in the market today resembles a print and sprint, where the manager quickly ramps the portfolio in a short time.

“A lot of equity investors are playing the option to buy the dip”

Michael Herzig, Senior managing director | First Eagle Alternative Credit

A recent report from Maples Group on the CLO market reflects these trends. In the piece published in May, the law firm said it was providing services for a record 88 open warehouses with an average age of 8.5 months, up from 82 warehouses a year ago, which had a much younger age. Maples found that warehouses that closed had a shorter duration of just 5.4 months.

“One can therefore conclude that, where deals are proceeding to successfully close, they are doing so quickly, but the market is proving challenging generally, leading to a growing number of open warehouses that are continuing to ‘age’,” read the report written by Maples partners Scott Macdonald and James Reeve.

Firms establishing warehouses capable of profiting from a sell-off will be hoping for a repeat of the 2008 vintage, which saw the highest returns to equity in CLO market history. A similar pattern played out in 2020 when firms traded on the sell-off following the onset of the covid-19 pandemic.

The risk is that everyone has the same idea, with the record number of warehouses providing a floor to the loan market when the sell-off eventually occurs. “New issue loan supply is limited, so when you see volatility, people will all be trying to buy the same thing,” says First Eagle’s Herzig.

In May, CLO primary activity increased in the US and Europe. $9.7 billion of CLOs priced in the US, up 28.3% from April, while Europe saw a 92.4% increase on the month, to €2.3 billion.

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June 2023 | Issue 255

Published in London & New York.