CLO Volume: Do I Hear $40B?

In the first quarter, $30 billion seemed a lofty forecast for 2012 issuance of CLOs. Now, the market appears to be headed toward $40 billion by year’s end. 

In September, collateralized loan obligation volume hit that $30 billion mark; and total CLO issuance year-to-date stands at more than $33 billion via 78 deals, according to Royal Bank of Scotland analysts.

In light of promising market conditions and a robust deal pipeline, analyst predictions are now coming in at $35 billion or more for the year.  “We believe managers and arrangers will try to maximize the amount of deals to take advantage of favorable current market conditions,” Kenneth Kroszner, a CLO strategist with RBS, said in an email. “Given the recent surge in the primary market, we anticipate issuance totals to reach between $40 billion and $45 billion by year’s end.”

One market player noted roughly 25 deals in the pipeline, with many managers pushing to theirs done by the Thanksgiving holiday. All of this means that the last few months of 2012 could see as much CLO volume as all of 2011, when approximately $13 billion priced.

The most recent deal raised, by Apollo Management, was also the year’s largest backed by widely syndicated loans at $722 million, topping a $719 million fund raised by Ares Management in August. ALM VII is Apollo’s third CLO this year, the firm said in a statement. It priced a $436.7 million transaction in February and a $514 million CLO in June.

The majority of this year’s surge in volume has been ushered in by private-equity backed CLO managers, such as Apollo and Blackstone/GSO, as well as market veterans, such as Ares and Credit Suisse Asset Management. But the market has also seen managers with just a couple of deals under their belt return this year for the first time since the crisis. And debut issuers—such as Sound Point Capital Management and Valcour Capital Management, which priced their first CLOs in September—have made their mark as well, albeit a small one compared to private equity-backed behemoths.  

Making all of this new issuance possible is significant demand for CLO paper. With the Federal Reserve keeping interest rates near zero in an attempt to boost the economy, investors are on a hunt for yield. And for highly rated investments, CLOs offer attractive spreads compared to other asset classes, which is drawing in regional banks and institutional investors such as pension funds, endowments, and insurance companies.

“I think the search for yield is very significant in driving the market. CLOs have now really hit the radar screen of those trying to get additional yield,” said Julian Black, head of structured finance at Appleby. “On that point, compared to say, credit cards, the triple-As on CLOs can yield seven times as much as the triple-As on credit cards.” 

Spreads on new-issue CLOs, while trending in, are in the area of Libor plus 140 bps for triple-A paper (down from the 150s during the summer). “As most other triple-A securitized products are well inside 100 bps, CLO triple-A’s offer significant value, especially in the context of bank return on equity,” JPMorgan analysts noted in a Sept. 22 report.

The analysts reckon that spreads will tighten to 125 bps by the end of the year. However, this is still wider than the low of 120 in June and July of 2011. They go on to forecast year-end mezzanine spreads, with triple-B’s at Libor plus 500 bps, and double-B’s at Libor plus 650 bps.

“We’re now seeing new investors buying at all levels of the capital structure,” a CLO manager said. “And that wasn’t necessarily the case earlier in the year.”

Another phenomenon allowing smaller, lesser-known managers to enter or re-enter the market has to do with the ability to get a deal done without a warehouse. Warehousing—buying and holding the underlying assets for a CLO before launching the deal—was common practice before the crisis, enabled by investment banks providing 100% warehouse funding.

That funding stopped after the financial meltdown; banks now typically require the CLO manager to put up roughly 20-25% of the “seed” money themselves. This, along with a considerable amount of industry consolidation, could have portended a market made up exclusively of mangers backed by deep-pocketed private equity and insurance companies. But lucky for the new kids on the block, market conditions have eliminated the requisite of a warehouse. 

That’s because, while loan prices have recovered substantially since the financial crisis, it is still possible to buy a significant amount of assets on the secondary under par, which means that a CLO manager can now print a deal, with the promise of what will be bought and at what price, then snatch up secondary market loans after the fact.

Market participants say roughly 40% to 50% of today’s new-issue CLOs are warehoused.