CLOI - CLO Debt Could Benefit From An Expected Slowdown In CLO Issuance
2023-07-08 02:55:00 ET
Summary
- An expected reduction in CLO issuance could support CLO debt spreads as investors sour on sub-standard new-issue CLO equity returns.
- ontrary to popular belief, new-issue CLO supply has been relatively strong this year.
- Through the end of June, $44 billion in U.S. CLOs were issued, excluding private credit CLOs. That is down 33% from last year’s near-record volumes but still on pace for $88 billion over full-year 2023.
By Pim van Schie
An expected reduction in CLO issuance could support CLO debt spreads as investors sour on sub-standard new-issue CLO equity returns.
Much has been written about the fundamental outlook for collateralized loan obligations (CLOs) and the underlying loan market. But what about CLO supply and the resulting technicals for CLO debt?
Contrary to popular belief, new-issue CLO supply has been relatively strong this year. Through the end of June, $44 billion in U.S. CLOs were issued, excluding private credit CLOs. That is down 33% from last year’s near-record volumes but still on pace for $88 billion over full-year 2023. 1
This CLO supply has come despite virtually no net new issuance in the loan market, which has actually decreased in size year-to-date. Newly issued CLOs are sourcing the vast majority of loan portfolios in the secondary market, leading to firm loan prices.
In addition, the steady stream of new issue CLOs has contributed to keeping CLO debt spreads wide. CLO debt spreads across the rating spectrum are still trading around the ninetieth percentile of the past five-year range.
So, what drives CLO supply? Ultimately, equity investors control the decision to issue CLOs and the timing of issuance. The motivation for issuing a CLO is the expectation to generate attractive returns from capturing the excess return between assets and liabilities.
Since new-issuance CLO equity returns depend on loan prices and the cost of financing, firm loan prices and the high cost of CLO debt have resulted in lower expected returns for new-issue CLO equity.
Normally speaking, lower expected new-issue CLO equity returns should result in reduced CLO issuance, which, in turn, should lead to lower loan prices and tighter CLO debt spreads until the point at which new-issue CLO equity returns make sense again.
This year has bucked that trend, however, as CLO issuance has continued despite lower expected new-issue CLO equity returns. CLO managers with captive CLO equity capital have issued based on a range of motivations, from terming out a temporary warehouse financing line to achieving broader business growth and AUM objectives.
We expect that, in the second half of the year, CLO managers may become more judicious with their remaining CLO equity capital and increasingly wait for a better expected return environment. This should lead to a slowdown in CLO supply and create a technical tailwind for CLO debt spreads.
1 Pitchbook LCD
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CLO Debt Could Benefit From An Expected Slowdown In CLO Issuance