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March 16, 2018  

European CLOs Encounter Rough Period

Collateralized loan obligation issuers in Europe suddenly are having a harder time placing the senior portions of their deals.

While characterizing the situation as temporary, industry participants said a number of factors are at play — including the approaching fiscal yearend for investors in Japan and an over-supply of offerings from first-time issuers. The upshot: Spreads on senior CLO paper in the region have reached their widest point this year.

A deal that Citigroup arranged for Prudential on March 2, for example, included a 5.5-year class of triple-A-rated notes that priced at 75 bp over three-month Libor. Citi also led a deal for Brigade Capital on March 12, placing the top piece at 76 bp.

In late February, similar transactions were pricing about 3 bp tighter.

Among banks in Japan, many have curtailed their bidding as they wait for new budgets to kick in with the April 1 start of their fiscal year. Those institutions have been among the biggest buyers of senior CLO securities in Europe in recent years, and are expected to return en masse after setting their 2018 allocations.

As for new issuers, some appear to be holding out for spreads that are comparable to those on deals from their more-active peers. That is creating a situation in which dealers are placing most of those firms’ notes, while taking down small senior interests that they could instantly list on the secondary market or hold in hopes of tightening spreads. “I’ve heard of a lot of situations where the deals are getting 90% done,” one investor said. “There are more deals from first-time managers in the market, and they want to catch the same bid as the established guys.”

With overall supply still running strong, meanwhile, one issuer said investors feel little urgency to chase specific offerings.

Spread movements among senior classes tend to have a magnified effect on deal economics, considering that those pieces typically make up about 60% of a CLO’s initial balance. Still, the prevailing opinion is that the market will remain on a bullish trajectory over the long term. “You can’t run in one direction forever,” one dealer said. “At times, you have to take a breather.”

Helping to buoy demand at the senior level is the fact that Japanese buyers can collect larger returns on deals from Europe than they can on U.S. offerings with wider spreads, due to currency-swap costs. And investor interest in mezzanine and junior notes remains strong. Mergers-and-acquisitions activity in Europe appears to be picking up as well, which could help issuers overcome a recent shortage of collateral as more loans are written.

Issuers in Europe completed $5.7 billion of CLOs from Jan. 1 to March 14, according to Asset-Backed Alert’s ABS Database. That’s the highest year-to-date tally since 2007. The full-year 2017 total of $22.2 billion was the highest since before the credit crisis.