Spreads Widening as CLOs Crowd Market
A recent decline in funding costs for collateralized loan obligations has reversed course.
Spreads on newly issued CLO paper had been tightening through October. But an Oct. 31 deal from Oak Hill Advisors showed a sudden erosion in the market for mezzanine notes, with underwriter Morgan Stanley placing an 8.9-year class of triple-B-rated securities at 415 bp over three-month Libor (see Initial Pricings on Page 10).
That’s 10 bp wider than prevailing levels from a week earlier. And on Nov. 1, GSO Blackstone priced a 8.1-year, triple-B-rated piece of a $562 million offering at a 425-bp spread, with BNP Paribas running the books.
Industry participants say the culprits are broader financial-market volatility and an oversupply of new deals, many from issuers that want to squeeze in transactions before the Dodd-Frank Act’s risk retention rule takes effect on Dec. 24. Indeed, $8.4 billion of fresh CLOs priced in the U.S. in October, on top of $8.2 billion in September and $6.1 billion in August, according to Asset-Backed Alert’s ABS Database. And that doesn’t include a recent wave of refinancings. “A little bit of mushiness has developed in the past week in both the loan and the CLO market,” one manager said. “There is so much supply that things are starting to get soft. The $64,000 question is whether it gets super sloppy.”
With spreads widening, meanwhile, many are questioning whether the still-packed pipeline of deals will produce as much volume as expected in the coming month-and-a-half. Issuers in the U.S. have completed $54 billion of offerings so far in 2016, and the tally eventually is expected to reach about $60 billion — unless continued spread widening erodes arbitrage opportunities.
On that front, sources pointed to the presidential election, a possible interest-rate hike by the Federal Reserve and a weakening junk-bond market as potential causes for concern. “There are a lot of things building . . . Whether the market shrugs it off or reacts to growing volatility is anyone’s guess,” one issuer said.