February 17, 2017
The CLO primary market experienced a busy November and December as issuers rushed to issue new deals or refinance existing deals ahead of the Dec. 24, 2016, risk retention deadline. In the secondary CLO market, the BB CLO rally has been nothing short of breathtaking. Securities that traded at dollar prices in the low 60s in late February 2016 traded in the low 90s in December, and in the high 90s in early January 2017. U.S. asset managers seeking low-risk floaters, and Asian investors seeking dollar-based credit, have driven up senior CLO tranche prices. The entire CLO capital structure reached post-crisis tights in the first weeks of 2017. Despite this tightening, the CLO arbitrage (bank loan yields minus the cost of CLO liabilities) remains challenged with loan spreads tight, Libor levels surpassing floors, and newissue volumes meager, restricting the pace of new-issue CLO creation.
Even as CLO debt spreads tighten, the CLO arbitrage—the difference between bank loan spreads and the cost of CLO liabilities in basis points—remains tight, helping to restrict the pace of new CLO issuance.
Source: Intex, S&P, Moody’s, Wells Fargo Securities, Guggenheim Investments. Data as of 12.31.2016.
Outside of CLOs, we expect a heavy calendar of aircraft lease securitizations in 2017. In October, HNA Group’s Avolon unit acquired CIT’s commercial aviation leasing business for about $4 billion, highlighting two aircraft market trends: significant capital markets activity, and Asian investors seeking dollar assets. Meanwhile, consumer performance observed in traditional ABS, such as credit cards and auto loans, remains strong.
According to J.P. Morgan’s benchmark CLO indexes, CLOs returned 1.01 percent in the fourth quarter, with lower quality tranches outperforming. For post-crisis CLOs, BB-rated tranches returned 4.87 percent, compared to 2.13, 0.81, 0.80, and 0.58 percent for BBB, A, AA, and AAA tranches, respectively. Spreads tightened across all tranche ratings, ending the quarter at or near their post-crisis tights.
Given current CLO debt valuations, we prefer less credit risk and spread duration, favoring the shorter AA and A-rated tranches offered in refinanced 2013–2014-issued deals. Investment-grade tranches of middle market CLOs continue to offer a significant spread pickup versus CLOs backed by broadly syndicated loans. As CLO spreads continue to tighten, we find new issue CLO equity tranches intriguing, as a contrarian may wish to lock in those tight liabilities anticipating wider entry points to buy loans during a four- to five-year reinvestment period. Within ABS, we have observed a stabilization within the shipping container market, and find value in select container ABS issues and aircraft lease securitizations.
CLO prices have been driven up by strong demand from U.S. managers seeking low-risk, floating-rate assets, and Asian investors looking for dollar-based credit.
Source: JP Morgan, Guggenheim Investments. Data as of 12.31.2016.
—Matt Lindland, Senior Managing Director; Michelle Liu, Director; George Mancheril, Vice President
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