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January 20, 2017  

Loan Scarcity Dampening Outlook for CLOs

Collateralized loan obligation professionals are fretting over declining yields in the corporate-debt market.

The matter stems largely from a trend in which borrowers have been able to negotiate lower interest rates on existing loans. Those “repricings” began to build late last year but especially took off in recent weeks, with the Jan. 1-17 total of $49.9 billion already representing the highest total for any full month.

The previous record of $48.6 billion was set in January 2013, according to Loan Commentary and Data, a service run by S&P Global Market Intelligence.

The problem for securitization specialists is that the repricings haven’t been accompanied by a corresponding tightening of spreads among new CLO notes — and thus have reduced or eliminated arbitrage opportunities for would-be issuers of new bonds backed by the renegotiated accounts. The upshot: A recent lag in CLO issuance is expected to continue.

“There will be a period of time where it would be almost foolish to do a deal given these levels,” one issuer said, referring to the reduced interest rates achieved through the repricings. Those agreements saw the average borrower cut its interest rate by 75 bp, to as little as 300 bp over three-month Libor.

The issuer added that lenders eventually will balk at further reductions, however. And in time, CLO spreads are expected to tighten to economical levels.

For now, five-year senior notes with triple-A ratings appear stuck around 135 bp over three-month Libor. But Citigroup estimated in a Jan. 17 report that they could tighten to 125-130 bp, while acknowledging that the situation could remain a near-term drag on issuance.

The repricing surge fits into a broader trend in which the prices of new and existing loans also have risen amid a dip in fresh lending activity — factors that also have added to the difficulties in bringing CLOs to market. Indeed, amid a tepid volume of mergers and acquisitions, U.S. leveraged-loan volume fell from $86 billion in September to $24.8 billion in December, according to S&P.

What’s more, CLO issuers increasingly have found themselves bidding against loan-focused mutual funds and exchange-traded funds when seeking collateral for their deals. Investors poured $11.8 billion into retail loan vehicles during the second half of 2016, reversing $5.6 billion of first-half outflows, according to S&P.

“Too many buyers, not enough loans,” one CLO investor said.

An issuer pointed to a $5.5 billion loan to Dublin-based Avolon, which in October agreed to purchase CIT’s aircraft-leasing business. After hitting the market this week, the newly written facility attracted more than $12 billion of offers. “The arbitrage and loan scarcity are intertwined,” the issuer said, citing low loan yields across the board. “Given the current CLO liabilities, it just doesn’t work at all.”

The loan-pricing squeeze comes at a time when the December implementation of the Dodd-Frank Act’s risk-retention rule already has driven some issuers out of the market. For now, new-deal supply remains dominated by refinancings of older transactions. Some issuers are preparing to come to market, however. Octagon Credit is shopping a deal with Citi running the books, for example. CIFC also is lining up a transaction via Deutsche Bank, while MJX Asset Management works on an offering with Jefferies.

Citi said in its report that total CLO issuance in the U.S. could hit $65 billion to $80 billion this year. That would compare to $72.4 billion in 2016, according to Asset-Backed Alert’s ABS Database.