CLO managers are already testing appetite to take AAA spreads even lower for deals currently being marketed to bond buyers, according to people with knowledge of the situation.
Tighter spreads will likely encourage more collateral managers to launch new CLOs as they improve the arbitrage, or the difference between cost of funding CLOs and the returns on the underlying loans. CLO equity investors who decide whether to issue a deal stand to make more money the wider the arbitrage gets.
A resurgence in new CLO formation, in turn, could spur leveraged finance desks to underwrite deals at lower yields to better compete against direct lenders.
“When banks see that CLOs are opening a lot of warehouses and increasing demand for leveraged loans, that gives them confidence to underwrite at competitive terms against private credit,” said Boris Okuliar, co-head of global liquid credit at Ares Management.
Banks are looking to arrange debt packages for a number of high-profile leveraged buyouts currently seeking financing, including multibillion-dollar deals supporting the acquisitions of Cotiviti Inc., German metering firm Techem GmbH and DocuSign Inc., Bloomberg previously reported.
Tighter liabilities are also making it more attractive to reset, reissue or call older CLOs as managers rush to shed older, higher cost debt.
What’s more, with roughly 40% of CLOs nearing or exceeding deadlines for when they can buy new loans—known as their reinvestment period—more are returning capital to investors. Many money managers holding the securities are looking to reinvest the funds back into newly issued CLOs, adding to demand.
“The market will be very different in 2024,” said Lauren Law, portfolio manager at Octagon Credit Investors. “In contrast to 2023 and much of 2022, we anticipate more activity—more calls, more resets, more issuance.”
To be sure, even after rapidly tightening, current spreads of roughly 1.5 percentage point on CLO AAA bonds are still wider than their average of 1.36 percentage point between 2011 and 2020, a period when the volume of CLO debt expanded rapidly. Whether spreads fall far enough to compel not only plenty of resets and refis of existing debt but also growth in the overall size of the CLO universe remains to be seen.
Some fund managers are confident CLO creation will pick up in 2024.
“We’ll see more demand than a lot of the sell-side research is expecting,” said Lauren Basmadjian, global head of liquid credit at Carlyle. “Some are expecting a down year versus an already low issuance year. I think the projections are low.”
This article was provided by Bloomberg News.