Robust supply is likely to continue: the removal of risk retention requirements offers market access to smaller managers, and the favorable economics of refinance and reset transactions encourages activity from existing CLO equity investors. From a fundamental perspective, CLO documentation standards remained relatively unchanged in the third quarter. A recent rating agency whitepaper called attention to increased leverage in CLOs’ bank loan collateral. As a result, that rating agency decreased the recovery assumptions for future loan defaults. While we do not expect the decreased recovery assumptions to immediately impact rating methodology, we are closely monitoring those collateral trends at this late stage in the credit cycle.
The esoteric ABS market continues to grow and currently stands at $22.5 billion. New issuance of franchise finance, structured settlements, maritime container, aircraft, and a collateralized fund obligation ABS were all successfully marketed, as esoteric ABS continues to benefit from a broadening investor base. The increased attention has driven spreads in some sectors to post-crisis tights, and in the case of franchise finance to spreads comparable to investment-grade corporate bonds. In this rally, we remain focused on less-followed subsectors in which we can capture information premiums instead of taking on additional credit or leverage-based risk.
We currently find value in short-tenor CLOs and select esoteric ABS. CLO supply pressures have flattened the term curve for CLOs to the point where defensive short-spread duration CLOs are now comparably priced to riskier longer-spread duration CLOs. We will remain focused on esoteric commercial ABS in the fourth quarter.
—Peter Van Gelderen, Managing Director; Josip Zdrilic, CFA, Director
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