Overview
On the face of it, volumes in the European CLO market are only falling slightly behind the record-breaking level of activity seen in 2021. As seen in this week’s Chart Room, deals totalling €16.4 billion have completed so far this year. Another four transactions worth €1.46 billion were priced in the first eight days of August [1]. In the U.S. too, volumes are not falling too far behind the levels seen last year, with $89.66 billion issued from 191 transactions in the year to August 15, compared to $100.42 billion across 207 deals at this point in 2021[2].
But despite the exuberant data, this has been one of the more difficult years for issuing new CLOs, the securitised vehicles that are the dominant investors in the leveraged loan market. After relatively normal issuance conditions in the first quarter of the year, by May and June the effects of the war in Ukraine and of weakening supply chains meant pricing conditions had become so uncertain that volumes nearly ground to a halt. Only one new CLO vehicle priced in Europe in the whole of June.
Arbitrageurs squeezed
A typical CLO works by arbitraging the difference between the cost of the payments to its rated debt investors and the income that the securitised vehicle receives from leveraged loans that it purchases on the primary and secondary market.
This year, liabilities have become more expensive: the weighted average cost of rated liabilities usually settles well below 200 basis points (averaging 176.11 basis points in Europe in 2021[3]) but recent deals have been seen above 300 basis points.
For much of Q2/Q3 2022, the average cost of the leveraged loans that CLOs buy has been creeping downwards. This has mitigated the negative impact on the arbitrage to some extent. However, as seen in a previous Chart Room, the loan market has rallied in the last few weeks, pushing the price higher and squeezing potential arbitrage.
Tougher conditions have prompted innovation
Some €2.65 billion of new CLOs were priced in Europe in July according to LCD figures, although many of this latest batch of deals have included structuring innovations to get them over the line against the difficult market backdrop[4]. For instance, recent deals have introduced options to add on delayed tranches of debt with certain ratings once market conditions turn more favourable to them. Other examples include issuers opting for shorter maturities or shorter reinvestment periods. In most cases, issuers and arrangers of CLOs are working with structural nuances on a deal-by-deal basis to get their transactions done.
Pent-up supply
Despite the innovations, not all deals have been successful, and several transactions were postponed in July and August. Those deals could come back in the coming months, despite a challenged market outlook. While this year’s annual volumes may not quite match up to 2021’s records, we are likely to see many more structural innovations before the year’s end.
[1] Arrangers piece together deals in strained European CLO market, LCD, August 11, 2022 lcdcomps.com/lcd/n/article.html?rid=261&aid=12495509
[2] Global CLO Roundup: Loan price recovery complicates CLO dealmaking, LCD, August 16, 2022 https://lcdcomps.com/lcd/n/article.html?rid=261&aid=12495611
[3] Global CLO Roundup: Market pressures pushing spreads close to pandemic wides, LCD, June 28, 2022 https://lcdcomps.com/lcd/n/article.html?rid=170&aid=12494402
[4] Global CLO Roundup: Debut issuer clears U.S. market; Europe records busy week, LCD, August 9, 2022 https://lcdcomps.com/lcd/n/article.html?rid=170&aid=12495442
