Outlook 2015: U.S. CLO issuance forecast strong but down from record 2014; Europe to grow

By Cristal Cody

Tupelo, Miss., Jan. 2 – After a record year of issuance in 2014, market appetite for CLO deals is expected to stay hearty in 2015 ahead of the start of risk regulations, according to market participants.

CLO issuance rose to more than $127.7 billion in the U.S. primary market and to €21.6 billion in Europe over the year, according to data compiled by Prospect News.

Primary issuance climbed from the $80 billion of U.S. CLO deals and €7.8 billion of euro-denominated CLO offerings that priced in 2013.

“2014 U.S. CLO issuance exceeded the prior 2006 record of $94 billion by 20%,” J.P. Morgan Securities LLC analysts said in a report. “We expect the CLO market to grow in 2015, albeit at a more modest pace.”

Forecasts for the year vary among market participants, with JPMorgan expecting U.S. gross supply to decline as much as 40% to $70 billion to $80 billion, based on risk retention fall-out, difficult arbitrage, collateral competition and competing refinancing supply.

“We expect issuance to slow down in the second half of the year as managers become more mindful of risk regulations and also as second tier managers determine if they will be able to bring deals,” one informed source said.

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, CLO managers must retain 5% capital of new deals beginning in 2016. U.S. CLOs brought before Oct. 21, 2016 will be grandfathered.

“In the near term, we do not expect the pace of U.S. CLO creation to be affected,” Barclays analysts said in a report. “We expect robust CLO issuance volumes in 2015, as managers pull forward deals that will then be grandfathered into the new regime. Not all CLO managers will respond to the regulations similarly, as smaller managers without the capital necessary to retain 5% may feel an increased urgency to create new issues.”

Forecasts for issuance

European CLO issuance is forecast at €20 billion with total global CLO volume of about $100 billion in 2015, JPMorgan said.

Barclays said it forecasts U.S. CLO issuance of $100 billion to $120 billion in the year ahead, while euro-denominated CLO issuance should reach €20 billion to €25 billion “thanks to the growing presence of U.S. managers and the proliferation of originator vehicles facilitating risk retention.”

Wells Fargo Securities LLC analysts forecast “another strong year for CLO issuance, but with a slight drop-off from 2014. Wells Fargo projects $90 billion in U.S. CLO issuance and €15 billion in European CLO issuance in 2015.

Several factors should contribute to a strong primary market in 2015, including managers that want to quickly build assets under management before risk retention compliance, a potential $50 billion in runoff from CLO 1.0 amortization and calls, increasing merger and acquisitions activity that should lead to new loan issuance and clarity on European risk retention rules that may expand the investor base for U.S. CLOs, Wells Fargo said.

Europe pipeline to grow

The European CLO market is projected to expand over the year.

“It has been challenging for managers to source pools with sufficient diversity and spread often resulting in a ramp-up of several months,” JPMorgan analysts said in a report. “In addition, there may be a number of ways to structure Volcker compliance, but many CLOs have retained HY bond buckets demonstrating the challenge of a loan-only CLO in Europe. However, conditions appear to be easing.”

CLO issuance has been slow in Europe compared to the U.S. primary market’s rate since Europe put in place risk retention requirements in late 2011 following the financial credit crisis, sources said.

“The biggest reason for the slow recovery in European CLO creation has been regulation, particularly risk retention,” Barclays said. “The need to provide capital equal to 5% of each transaction is a significant obstacle for smaller managers. As a result, only three debut managers have participated in the European 2.0 market thus far, while more than 50 have done so in the U.S., where risk retention is not yet binding.”

Moody’s Investors Service said in an outlook report that it expects a modest increase in European CLO issuance in 2015 with new investors and new managers in the market.

In addition, some multi-currency CLO deals are possible over the year, Moody’s said.

“Deals with both multiple currency collateral pools and liabilities could come to market in 2015 because the most rapid Western European growth will likely occur in the non-euro denominated U.K. market,” according to the Moody’s report.

Year of $1 billion deals

The year behind marked the issuance of several $1 billion-plus CLO transactions in the U.S. and European markets, according to market sources.

Onex Credit Partners LLC sold $1,001,750,000 of notes in the OCP CLO 2014-6 Ltd./OCP CLO 2014-6 Corp. offering on May 22, 2014. The firm priced the AAA tranche at Libor plus 145 basis points.

BofA Merrill Lynch arranged the deal.

Apollo Credit Management (CLO) LLC priced the $1,542,100,000 ALM XIV, Ltd. CLO on June 6 and placed the AAA notes at Libor plus 143 bps. JPMorgan was the placement agent.

Credit Suisse Asset Management, LLC raised $1,036,000,000 in the Madison Park Funding XIV Ltd./Madison Park Funding XIV LLC deal on July 7 via Morgan Stanley & Co.

The CLO priced the AAA slice at Libor plus 145 bps.

Ares Management LLC sold $1.26 billion of notes in the Ares XXXI CLO Ltd./Ares XXXI CLO LLC transaction on July 30 via JPMorgan.

The CLO priced the AAA-rated notes at Libor plus 144 bps.

Late in the year, Banco Santander SA sold €4.56 billion of notes in the FTA Pymes Santander 10 deal.

The CLO priced the AAA-rated notes at Euribor plus 106 bps on Nov. 27.

Banco Santander arranged the transaction, which is secured by loans and credit lines by Banco Santander and Banco Espanol de Credito, SA to small and medium-sized enterprises and self-employed individuals in Spain.

The Madrid, Spain-based bank also brought the €1.86 billion FTA Pymes Santander 8 deal on May 20, 2014.

Regulations slow primary

U.S. CLO primary action cooled at the beginning of the year in response to the Dec. 10, 2013 release of the risk retention regulations under the Dodd-Frank Act.

The year’s first CLO deal priced on Jan. 28, 2014, according to a market source.

LCM Asset Management LLC sold $624 million of notes due 2024 in the LCM XV LP/LCM XV LLC transaction via Morgan Stanley & Co. LLC. LCM priced the AAA tranche at Libor plus 150 bps.

“2014 got off to a slow start with only $2.5 billion supply in January following the shock of the Volcker Rule,” JPMorgan analysts said. “The market shrugged it off with a record stretch from March to August of $10 billion or more each month. As the year progressed, supply technicals proved overwhelming with historically large deals/upsizes, and issuance has limped into year-end with the highest all-in liability costs since late 2012.”

At the start of the year in January, about 56% of U.S. CLOs and about 57% of European CLOs had bonds in their portfolios, according to a Wells Fargo Securities, LLC report.

By the end of the year, virtually all U.S. CLOs priced without bonds in the portfolios. European CLOs had started to conform by late in the year, market sources said.

“While a number of European CLOs were issued in noncompliant form during the first half of 2014, second half issuance strongly suggests that Volcker compliance is now the norm for Europe,” according to Barclays. “In fact, as of late November, the last three CLOs to price had each chosen a different compliance route, including bond bucket elimination, incorporation under Rule 3a-7, and non-voting AAA tranches. We believe all of these options will remain in use in 2015, but would expect loan only securitizations to gain share due to the expected influx of U.S. managers.”

CLOs refinancings increase

The Volcker regulations are expected to keep CLO refinancing supply steady in 2015, sources said.

“Efforts to comply with Volcker – primarily by dropping bond buckets – will continue to drive some refinancing activity,” Barclays said. “With approximately $50 billion of CLOs exiting their non-call periods before July, we expect the trend of managers Volckerizing their structures to continue into next year.”

Early 2013 vintage CLOs are not likely to refinance under current market conditions, but late 2012 and late 2013 vintage CLOs are “strong candidates in the upcoming year,” JPMorgan analysts said.

“With the number of issuing managers likely to decrease as the rule gets closer, we believe refinancings will likely play a bigger role in the primary market, of course to the extent the investor market for shorter paper grows,” JPMorgan said.

CLO managers refinanced 21 vintage CLO deals in 2014, compared to five CLOs refinanced in 2013, sources report.

Refinanced CLOs on average tightened to Libor plus 122 bps in 2014 from Libor plus 149 bps, according to Barclays.

On Jan. 15, Prudential Investment Management, Inc. refinanced the $304.85 million Dryden XXII Senior Loan Fund/Dryden XXII Senior Loan Fund Corp. deal via RBS Securities Inc., according to the firm and market sources.

The original offering of $195 million of class A-1 notes due Jan. 15, 2022 that priced at Libor plus 153 bps in 2011 was refinanced to class A-1-R senior secured floating-rated notes (Aaa/AAA/) at Libor plus 117 bps.

The CLO is backed primarily by broadly syndicated first-lien senior secured corporate loans.

New Issue AAAs range-bound

New issue U.S. CLO AAA notes mostly held to the Libor plus 150 bps to Libor plus 155 bps area over 2014, and spreads are not forecast to tighten much in 2015, sources said.

AAAs tightened as much as Libor plus 110 bps in 2013.

“So far, CLO AAA spreads have underperformed partly due to the lower yields,” according to the JPMorgan report. “Although new-issue AAA spreads have remained stubbornly high in 2014 and failed to meet our L+135-140 [bps] forecast, we remain optimistic that in 2015 AAAs will tighten and hit this forecast by 2015 year-end.”

New issue spread tightening likely will be limited based on an “ambitious primary calendar,” Wells Fargo said. “We see few catalysts for widespread tightening, as CLO supply tends to equal CLO demand.”

Euro new issue CLO spreads are expected to remain tight in 2015, market sources said.

“Based on the last few deals to price in each market, European AAAs [at Euribor plus 125 bps-127 bps] are being issued roughly 30 bps inside of where U.S. deals are pricing [at Libor plus 155 bps-160 bps],” Barclays said.

Secondary CLOs widen

CLO secondary spreads have been mostly “stagnant” over 2014 but were closing out weaker, according to the Barclays report.

“Secondary CLO 2.0 spreads are wider than year-end 2013 levels, as heavy supply throughout the year has left little room for tightening,” Barclays said. “Spreads are wider across the ratings spectrum: AAAs are 10 bps wider, AAs are 50 bps wider, single As are 30 bps wider, BBBs are 50 bps wider, and BBs are 18 bps wider.”

The weakness has led to a widening in the gap between U.S. and European AAAs to more than 25 bps, Barclays said.

The large U.S. primary supply “is the main cause of the spread widening,” according to Wells Fargo.

“Amid heavy primary volume, secondary spreads have tended to lag, as investor attention is focused on new issues,” the Wells Fargo report said. “We believe that notes from non-Volckerized CLOs will trade at a discount to Volckerized tranches, due to liquidity concerns, and we think Volckerized tranches should tighten.”

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