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November 2023 | Issue 259
News
US primary market shrugs off worries and keeps on issuing
Tom Davidson
Managing editor
Widening spreads don’t seem to be slowing down the US CLO primary market.
According to our data, 23 broadly syndicated deals priced in October, with most of that issuance happening in the last half of the month.
Despite this rush of new deals, spreads are clearly moving back out. The average US triple A spread in October was 180.5bps, five basis points wider than in September (see chart).
According to one banker, that’s more a reflection of market technicals than anything fundamental. “The demand for senior paper from banks will remain muted for now. I’ve heard that the biggest Japanese investors are done for the year, and domestically the tier one buyers only have an axe for shorter duration paper.”
2023 US BSL AAA spreads (bps)
Although that may be the case at the senior level, the fading hopes of a soft-landing for the US economy seem to be weighing heavily on other investors’ minds. That topic was a common refrain at last month’s ABS East 2023 conference in Miami.
On the imaginatively titled ‘CLO-sing in on yield: Investor perspectives across the capital stack’ panel, much of the discussion focused on the fact that, despite increasing credit problems in the underlying assets, new issuance will continue.
Ares’ Cheng Zeng summed this up: “We’ll see defaults, we’ll see triple Cs rise, but we’ll still see managers price.”
Hong Zhao, head of CLO trading at Societe Generale, predicted that market technicals could push triple A spreads down as far as 140bps next year.
But Steve Page, a managing director at Barings, took a different view. “I’m mildly bearish on CLO spreads given the potential for defaults to continue to tick up next year (though not massively from here),” he said.
Page also expects loss-given default to increase on the back of lower recoveries. “CLO BB spreads could widen by 50-100bps,” he said. “But we still like the asset class given historically high current coupons provide a nice margin of safety against spread widening.”
Away from the new issue market, many delegates were expecting an uptick in resets, but driven more by the opportunity to do a par flush than by reducing the cost of debt.
Another topic adding to uncertainty came from US regulators. Although there have been some recent wins for the loan market against the SEC, it’s another regulator taking the spotlight now — the National Association of Insurance Commissioners.
The NAIC is in the middle of developing a new financial modelling process for CLOs, with an ad hoc committee created to develop the specific methodology. While the model itself is still pending, the mood coming from the NAIC remains concerning.
At ABS East, Eric Kolchinsky, director of the structured securities group at the NAIC, explained that, while the NAIC itself doesn’t have any end game, it is directed by the views of state-based insurance regulators.
He went on to flag the current situation, where the risk capital requirements of a pool of loans drops in half when they become tranched up in a CLO, as cause for concern.
Given the critical role of insurance investors in CLOs, the market will be keeping a close eye on this process.
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Global credit funds & CLO's
November 2023 | Issue 259
Published in London & New York.
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