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February 15, 2019  

Wider Spreads Curtail CLO Refinancings

The refinancing trade for collateralized loan obligations has dried up.

Many industry professionals were banking on another wave of deals in the first quarter, after which the expectation was that volume would gradually decline. But wider spreads on CLO notes have virtually eliminated the economic incentive for refinancing. Consider that only four such deals priced in the first six weeks of this year. The same period saw 41 deals in 2018 and 42 in 2017, according to Asset-Backed Alert’s ABS Database.

A flood of CLO refinancings in the past two years has allowed issuers to substantially lower their funding costs and, in most cases, extend the deals’ reinvestment periods. It also has been a boon for bankers, lawyers and rating agencies.

One reason for the sudden slowdown in refinancings is that the sheer number of deals completed in 2017 and 2018 largely cleared a backlog of CLOs that priced from 2014 to 2016, when spreads were wider. But after hitting a low of about 100 bp over three-month Libor in February 2018, spreads have moved out to the point where senior securities with five-year lives are trading at about 136 bp.

As recently as December, many were predicting that the volume of refinancings would remain high through the first quarter. J.P. Morgan and Wells Fargo, in separate reports, forecast 2019 refinancings would total about $100 billion — well below the 2018 total of $147.9 billion, but still a substantial amount.

The relatively bullish outlook changed, however, after spreads widened in December. The latest forecast from Citigroup, issued Jan. 16, calls for just $40 billion of CLO refinancings this year.

One dealer said the refi market will remain on hold until spreads tighten again. And that likely won’t happen, he said, as long as a number of CLO warehouses remain underwater following a drop in loan prices in November and December. “The loan market has rallied back a lot, so the warehouses are a little underwater, nothing huge,” he said. “I think there is a lot of patience [among] the first-loss [investors]. We do not see any panic.”

Still, many issuers remain hesitant to offer new deals. From Jan. 1 to Feb. 13, 18 new CLOs totaling $9 billion had priced, compared to 26 deals totaling $13.5 billion during the same period last year.

One issuer said spreads likely will remain sloppy for a few weeks, then begin to tighten. The fact that senior CLO notes are trading about 8 bp wider than corporate bonds should draw investors back to the market, causing CLO spreads to tighten. That, in turn, could lead to an increase in deal volume both for refinancings and new issuance.

A potential headwind is three-month Libor, which in December reversed a prolonged climb and since then has fallen to 2.69% — cutting into investors’ returns.

Lauren Basmadjian, a senior portfolio manager at CLO issuer Octagon Credit, noted that the heavy refinancing activity in the past two years could lead to problems when the replacement deals mature all at once. “You could run into a maturity wall,” she said. “All those resets and new deals mean that five years from now, there could be a lot of CLOs ending their reinvestment period, meaning they stop being active buyers. That could be interesting.”