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April 06, 2018  

CLO Pipeline Shrinks Amid Gusher of Refis

Widening spreads on collateralized loan obligations appear to be deterring issuance at the start of what was expected to be a record month for deal flow.

Only a week or so ago, U.S. issuers had a total of 35 new deals in the pipeline for April. But only a handful of offerings were in the market this week, and the few completed deals priced wider than expected. Dealers and managers focused instead on a packed calendar of CLO refinancings that must close by the deals’ April quarterly payment dates.

“Dealers and managers have delayed putting deals into the market to let the wave [of refinancings] go by,” a CLO lawyer said. “They will pick it back up later this month when the refinancings clear.”

Others, however, said the recent widening trend could keep a lid on new issuance for some time. Spreads on mezzanine bonds started moving out about three weeks ago, and more recently on senior securities.

Take, for example, a $528.3 million offering that Citigroup placed on behalf of Fidelity Investments on April 4. The senior notes, with triple-A grades and 5.5-year lives, went out at 100 bp over three-month Libor — at least several points wider than similar paper that priced three weeks ago. The deal’s triple-B tranche priced at 328 bp, roughly 50 bp wider.

One investor described the drop in CLO values as “a big deal,” with the potential to force many issuers to the sidelines for weeks or even months — depending on where spreads go from here. “Three weeks ago, I would have told you that everyone will continue printing non-stop,” he said. “But this kind of broader widening makes people hesitate.”

Until now, U.S. issuers had been churning out CLOs at a record pace this year, with first-quarter deal volume totaling $34.3 billion, according to Asset-Backed Alert’s ABS Database. That shattered the previous first-quarter record of $30.7 billion in 2015.

Traders are attributing the widening trend more to an over-abundance of supply — particularly on the refinancing side — than to waning investor demand. But after months of spread-tightening, senior bondholders have begun complaining not only about paltry returns, but also about recent revisions to deal terms that favor equity investors.

“The debt investors saw there was an oversupply of deals, and they started to push back on spread and terms,” the lawyer said. “They saw an opportunity, and they are flexing their muscle.”

One trader also pointed to heightened bond-market volatility as a contributing factor. “There is macro weakness, volatility, trade wars, higher funding costs,” he said. “Some guys are taking profits and thinking it may be time to stick their head in the sand for awhile.”

Industry professionals also are pointing to a “price-tiering” trend in which investors are showing less appetite for deals whose terms are skewed in favor of equity holders. An increasing number of CLOs, for example, incorporate so-called par-flush provisions that direct trading profits to the deals’ equity classes.

Case in point: On March 21, Morgan Stanley priced a deal with a par-flush provision on behalf of Prudential. A mezzanine tranche rated double-B yielded 575 bp over three-month Libor. The same day, Citi priced a deal for Aegon USA without the par-flush feature. The double-B tranche priced 40 bp tighter.