European CLO Market Success Throughout the Pandemic; Outlook for 2022
At the end of last month, Trepp attended the 25th annual Global ABS conference both virtually and in person. At the in-person event on September 27th-28th, Trepp attended a number of sessions discussing the current outlook for the European CLO market. In fact, Andrea Tortora, Trepp's Head of European Modelling and Content, and Taranjeet Chumber, Trepp's Assistant VP, Team Leader appeared on two panels at the conference. Tortora spoke at The European CLO Market Round-Up and Chumber moderated the CLO Investor Outlook. Here we outline some of the key takeaways from the CLO Investor Outlook, trends we have noted in the CLO market since the onset of COVID, and what we can expect to see over the next 12 months...
Strength and Success
Last week, Trepp noted that the $1 trillion threshold for global CLO issuance had been reached, and the market has not stopped this march toward a record-breaking year, with intense activity reported in both July and August. Trepp noted some key factors that underpin the strength and appeal of the CLO asset class that has been seen over the last few months. On a global level, these include interest from the largest US banks toward the senior portions of the capital stack, and a general repositioning towards floating-rate debt, such as typical CLO notes, to protect against the prospect of rising rates. In addition, loan prices have enjoyed a market-wide increase to date based on technical and economic factors.
In the CLO Investor Outlook panel at Global ABS, Taranjeet highlighted this market success and how well CLO structures withstood the turbulence caused by the COVID-19 pandemic, and the confidence this has created in the CLO asset class. The market has seen record levels of supply due to an equilibrium between loan issuance and CLO issuance and this issuance is expected to increase. Panelists on the CLO Investor Outlook also highlighted that CLO’s are highly diversified, actively managed, and have a structure that was very effective during the pandemic and helped to reduce the risk. This can be illustrated by the fact that defaults in the leveraged loan market were higher during the pandemic than the defaults in CLO’s. In fact, next year, panelists predict loan default rate increases as a result of withdrawn liquidity and a possible taper tantrum. However, this should not have too heavy of an impact on the asset class performance.
The CLO Investor Outlook
The CLO Investor Outlook panel at Global ABS, moderated by Taranjeet Chumber, included four panelists and experts in the industry; Vedanta Bagchi, Director, Investment Office at Commerzbank AG, Peter Glysteen, CEO of AGL Credit Management, Matthew Layton, Partner at Pearl Driver Capital, and Gabriele Gramazio, Director at KBRA. To begin the conversation, panelists were asked if there were any post-pandemic effects yet to be seen in the CLO market? The general consensus — the effects of the pandemic have been fully absorbed, but, the market has seen a change.
Panelists agreed that the current strength of new issuance, secondary loan prices, and default rates in the market suggests there was no real downturn, and while panelists throughout the conference were reluctant to say all the impacts of the pandemic are over, many believe a lot of the effects of 2020 and the pandemic have been absorbed by the credit markets. With that being said, the market has seen a change over the past eighteen months. As discussed above, CLO issuance has reached record levels, and this is driven by a need for yield, and supported by record loan issuance — the market is balanced. Asset managers appear to be increasing their exposure to CLO's as a result of the market resilience and impressive performance throughout the past eighteen months.
Experts at the conference delved a little into changes in the structure of some CLO deals and the potential return to pre-pandemic structures, for example, longer reinvestment & non-call periods. While true, they also highlighted some of the new features that have appeared in the market over the past 18 months and that are likely here to stay. These include loss mitigation obligations and notes in the form of loans.
Recently, Trepp highlighted some of the changes seen in the CLO landscape since the start of COVID. The pandemic pushed market participants to consider changes to issuance structures and CLO documentation such as leverage, par, subordination, and reinvestment periods.
Trepp highlighted that arrangers have been discussing the introduction of new ‘CCC’ rated tranches. There are no tests for the 'CCC' bucket when a CLO goes live. Traditionally, for a CLO to become effective, the transaction documents have several tests, among them the extent of exposure to assets rated in the 'CCC' category. Some of the recent CLO transaction documents do not include such requirements or tests. In a nutshell, this means that a CLO can become effective irrespective of the exposure to 'CCC' rated assets in the pool.
Other developments include bigger bond buckets and no buckets for discounted assets. Recently, CLO managers have proposed the removal of the minimum loan bucket requirement, which is typically 70% of the CLO pool. This could allow CLOs to hold larger bond buckets than was previously the case. Although European CLOs have some exposure to bonds already, it is possible that the removal of this requirement could benefit the high-yield market.
Outlook for 2022
Bloomberg Law highlights that historically, the fluctuations in CLO issuances are highly correlated with supply and demand in the underlying leveraged loan market from merger and acquisition (M&A) activities, and with private equity firms entering the CLO market as both portfolio managers and borrowers. The CLO Investor Outlook panel highlighted that the cycle has a long way to go, and we should recognize the many changes that are occurring, including the record level of M&A due to business changes, which will likely continue into 2022.
On the subject of issuance when looking to 2022, panelists highlighted again the record levels already seen in 2021, and the expectation for continued success heading into 2022. Returns have been at a great level, and if this position can be maintained into the next year, the market will see further success. Panelists also did not seem to have concerns surrounding rising defaults, suggesting that CLO structures are designed to withstand that.
Since establishing our London office over a decade ago, Trepp has modeled all European CMBS deals and offers a rich data set that dates back to the origination of the CMBS market in Europe. With a staff dedicated to the European market, Trepp is acknowledged as the market leader in its analysis of bonds and generated cashflows.
Disclaimer: The information provided is based on information generally available to the public from sources believed to be reliable.