CLO Market Year-in-Review: The Return from Pandemic-Induced Distress
Leading into 2020, market participants were starting to voice concerns about the high amount of corporate leverage that had built up in capital markets. Nevertheless, the first two months of the year saw a lot of activity that was spurred by both a large amount of newly issued deals in the US and Europe – over $10 billion between the two countries – and newly refinanced deals. A month later, the world was halted by a pandemic, which led to managers and investors re-evaluating the strength of their CLO investments.
Pandemic Induced Distress
The shocking demand-side impact across the economy caused widespread distress in the CLO market as well. However, CLO market participants quickly grasped the severity of the pandemic and the underlying distress which shook the foundation of the market. New issuance was quickly decimated, coming in at only a fraction of what it was in 2019, and many loans underlying CLO deals saw a steep drop in their credit prices due to economic distress. March experienced the lowest total issuance of the year with only $3.3 billion in deals being priced across the US and Europe. This marks a 58% percent decrease from the same period the year prior. The following graph represents monthly issuance for the US and Europe in 2020.
This distress was also reflected in the median AAA spreads. In April, median spreads jumped to 221 in the US and 170 in Europe – a 99 and 62.5 basis point widening from March. In the months thereafter spreads in both countries began to tighten but in August they were still at least 35 points wide of where they started the year. These however saw a quick recovery and returned to their early 2020 levels by fall 2020. The following graphs show the median spread for newly issued deals in the US and Europe by month.
As we moved to the fall, the world began to gain its footing in the “new normal.” While some sectors continued to struggle due to reduced capacity and stay-at-home orders, others began to see the benefits of government-backed stimulus and forbearance agreements. This was once again mirrored in median CLO spreads, which began to tighten in September, dropping 42 basis points before hovering around L+130 throughout the rest of the year in the US. A similar trend took place in Europe as well, which saw spreads tighten as much as 42 basis points from summertime highs.
The Variation of Distressed Assets
While certain companies were able to take the initial blow and subsequently begin to recover, many others faced concerns that would last throughout the year. In April, companies felt the pressure of the economic downturn and experienced rating downgrades, facility sell-offs, and bankruptcies. This level of instant economic downturn also triggered the failsafes within many CLO deals, with almost 22% of all US CLO deals failing Junior OC tests in May. Fortunately, as the year went on, managers and investors became more confident in the market and in CLOs ability to weather the initial shock seen in the industry. In the last quarter of the year, issuance continued to rise and spreads tightened, generating positive market trends that have ushered us into 2021. Arrangers like Jefferies and Neuberger Berman have recently returned to the market.
Unfortunately, not all assets escaped the pandemic unscathed. The energy and retail sectors struggled mightily once the pandemic hit, and this has carried over into the CLO market. An analysis of loans trading at below 80 cents on the dollar shows that 22% of these are from companies in the energy and retail sector. This is followed by Business Services, Hotel, Gaming, and Leisure sectors which total to about 15%. These facilities are credited to large companies like AMC, Seadrill, and Crown Finance – whose performance and struggles we cover extensively in our TreppCLO product.
For some distressed loans, the answer to the pandemic has been refinancing, with CLO managers opting for static deals or ones with shorter reinvestment periods through 2020. Since the start of last year over 85 deals have been refinanced, 33 of which took place in January and February of this year so far.
2021... So Far
With relief on the horizon and high-efficacy vaccines becoming more accessible every month, the outlook for the rest of 2021 in capital markets has been positive. This year alone, over $23 billion in CLOs have been issued, $18.7 billion of which priced this month. Additionally, newly issued median spreads have been tighter this year, and in Europe specifically new issue benchmarks have been set and median spreads have come in at L+85, more than 15 points tighter than they were in December 2020. Having now weathered both the Great Financial Crisis, and the brunt of the pandemic-induced economic distress, CLOs look poised to continue their strides as a growing market for well-structured investments.
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The information provided is based on information generally available to the public from sources believed to be reliable.