United States: US CLO Market

2016 US CLO Market Review

Following a glacial start to the year and significantly depressed H1 issuance levels, which resulted in significant downward revisions by bank arrangers to their 2016 volume predictions (as low as $35 billion for the full year), 2016 ended on a more positive note than expected. US CLO issuance ended the year at approximately $72 billion across 156 deals, with nearly $50 billion in additional issuance via refinancing/reset transactions across 96 deals.

The busiest months in terms of activity were October, November and December which accounted for $26.21 billion in CLO primary issuance and approximately $37 billion in refinanced or reset deals. In contrast, H1 issuance totalled $27.12 billion from 66 deals and in 2015 refinancing volume was less than $10 billion in total. Bank arranger predictions, which at the start of 2016 were around the $70 billion mark, held true despite the downward revisions in March 2016 to $35-50 billion.

The onset of risk retention on 24 December 2016 accounted for the increased activity seen in November and December as managers sought to issue new deals, or refinance or extend existing CLOs in advance of the deadline and thereby avoid the 5% required holding for deals issued or refinanced after the deadline.

Maples Fiduciary's "Risk Retention Survey of US CLO Managers – Part II" released in December confirmed that 89% of CLO managers already had a risk retention strategy in place or ready for implementation imminently. A summary of the survey is included on page 11.

In terms of spreads, the year was bifurcated as the first six months saw a gradual widening of primary spreads. Conversely, H2 welcomed spread tightening to levels last seen in 2012, providing more favourable conditions to attract equity buyers. AAA pricing came down from the low 150bps mark to low 140bps by the end of the year.

Although defaults in credits related to oil and gas, mining and minerals were reasonably prevalent in 2016, other sectors such as healthcare, technology and retail, which had been expected to suffer defaults, saw a lot less stress than anticipated. Concern relating to credits in those sectors, however, does continue into 2017.

2016 saw a total of three BSL debut CLO 2.0 managers, namely Newfleet Asset Management (owned by Virtus), Teachers Advisors (an affiliate of insurance giant TIAA Global Asset Management) and Guardian Life. In the middle market, Churchill Asset Management, Brightwood and Alliance Bernstein all issued their first middle market 2.0 CLOs. This demonstrates continued confidence in the product from new entrants and the wider financial services market.

In 2016 94 different US managers priced one or more US CLOs across a total of 252 deals, which included 96 refis, across 247 Cayman Islands issuers and five Delaware issuers. That compared with 219 priced US CLOs in 2015 across 212 Cayman Islands issuers, six Delaware issuers and one Irish issuer. Carlyle, Credit Suisse Asset Management, Golub and GSO/Blackstone priced four or more new US CLOs in 2016.

Each of Bank of America, BNP Paribas, Citigroup, Credit Suisse, Goldman Sachs, Jefferies, J.P. Morgan, Morgan Stanley, Natixis and Wells Fargo have priced 12 or more deals (including refis and resets) in H2 2016, with Citigroup leading the pack.

Average deal size in 2016 was in the low $400 million range, compared with a $500 million median CLO size in 2015. At the end of the year we estimated that there were about 50 warehouses still open in the CLO pipeline, compared with the 60-70 open at the start of 2016.

For a complete list of the H2 2016 priced US CLOs, see Appendix 1.

US CLOs – What's in store for 2017?

Bank arrangers are predicting between $50-70 billion in issuance for 2017, with Nomura and J.P. Morgan predicting volumes at the lower end ($50-60 billion) and Morgan Stanley and Wells Fargo more bullish at around the $70 billion mark. The market anticipates a reduction in the number of managers issuing new deals as a result of risk retention and an increase in manager mergers and acquisitions. Predictions range for between 40-70 active managers remaining at the end of 2017, and the year started off with announcements that Marble Point (backed by Eagle Point) had acquired American Capital and New York Life Investments agreed to acquire a majority stake in Credit Value Partners. However, as mentioned previously, new entrants in the manager space (and we are aware of a number of others) will more than likely lessen the impact of any such manager contraction.

Some market participants are predicting, and we are already seeing, new issue spreads tightening with current deals already getting close to 130bps on the AAAs. We believe that AAAs will continue to tighten and could get into the low 120bps by year-end. At the time of writing, Octagon Investment Partners 30 set the lowest AAA new issue print this year at 132bps. Refinancing and repricings account for the greatest primary market activity so far in 2017 with nearly $8 billion in CLO repricings in January alone as managers and arrangers take advantage of tightening spreads and the Crescent Capital's SEC no-action letter. At the same time, the new issue market remains sluggish as managers continue to struggle to source new collateral at attractive prices. Making the arbitrage work on new deals is difficult at the moment which has not been helped by a wave of repricings at the primary asset level. Not only have the primary repricings been aggressive but the reductions appear to bare very little correlation to the credit quality of the obligor with spreads dropping significantly for all borrowers. This will continue to make issuing new CLOs a challenge for the foreseeable future, leading to several managers contemplating resets to extend the reinvestment period of existing CLOs. On the positive side of things, so long as dollar funding costs are not prohibitive, it is anticipated that Asian investors will continue to finance a substantial part of the senior CLO tranches and managers will continue to find themselves on roadshows in Korea and Japan, especially as certain Japanese banks extend their 'approved manager' lists and other investors increase their CLO investment allocations.

Many are hopeful that President Trump will take a more favourable approach when it comes to the regulation of the capital markets and some pundits have even suggested that parts of Dodd Frank could be repealed, even going so far as to suggest that CLOs may be exempted from the risk retention requirements. The view of many of the participants at the Opal CLO Summit at Dana Point in California in early December was very much that the market has positioned itself to deal with the risk retention requirements in the US, regardless of what President Trump may or may not do. Either way, it is pretty clear that the US will not look to embark on further burdensome regulation unlike the regulators in Europe who are now eyeing a possible move to a 10% risk retention requirement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Nicola Bashforth
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