The Last Word: Liquidity improves but doubts remain

Q – What’s your take on the collateralised loan obligations (CLO) market in Europe at the moment?

There has been a lot of talk this year about heavy new CLO issuance in Europe, as a result of the improved liquidity conditions. However, we’ve been pretty sceptical about the European CLO market for quite some time now although we do think it will come back in the long term. There is definitely more demand for raising CLOs in Europe. The liquidity component is falling into place, and that’s why we are seeing a slow rebirth. In relative terms, it’s still only an aggregate of $1 billion-worth of CLOs that have been raised so far, with an expected $3-5 billion still to come. This is still a tiny amount when compared to the US market.

Q – You ran a global CLO client survey, last month – can you talk me through some of your main findings?

Concerns regarding CLO origination were at the forefront of many respondents’ minds, as a result of lack of collateral, the lack of arbitrage and regulation. A third of investors reported high to very high cash returns. The buyer / seller ratio declined from 10.1x to 5.5x. This is less frothy than in the last quarter of 2012, but there are still many more buyers than sellers. In addition to US CLO 2.0, the survey indicates more demand for Euro CLO 2.0 (with or without large HY bond buckets) and some demand for emerging market-focused CLOs and CDOs.

Q – In relative terms, the CLO market has been in rude health in the US though hasn’t it?

The US market is definitely more advanced. Year to date issuance has surged up $27.8 billion, after an extraordinary first quarter performance. It is still not clear if the second quarter will be as robust, given the continued overwhelming re-pricing trend in high yield loans.

Q – Why are the dynamics so different in Europe?

Although there are some encouraging signs of CLOs making a comeback, the European market is really incomparable with the US market. There isn’t yet the breadth and depth of assets in the market to allow for CLOs to be raised. Also, a majority of the loan market is publicly-rated in the US, whereas in Europe dynamics are completely different, with two thirds of loans privately-rated.

Q – What about the pricing of CLOs?

It isn’t a major factor. There are bigger things hindering growth of CLOs in the European market.

Q – What are the main challenges ahead for the European CLO market?

Spreads are continuing to tighten with the underlying loans, so the economics are becoming more compelling. One of the main concerns is whether or not the LBO market is able to absorb new transactions with €70 billion-worth of CLO re-investment periods ending.

Q – What’s your prognosis?

The departure of those CLOs from the market will leave a big hole in the continent’s credit supply. The only way that gap will be filled is with the issuance of new CLOs or new sources of credit coming to the fore unless companies find alternative means of financing such as high yield bonds. It’s unclear whether there will be a new generation of CLOs, but some institutional fund managers are working hard to develop alternative debt structures.

Q – And an overall CLO forecast in quantitative terms?

We still think 2013 will witness up to $70bn of US CLO supply. Add a Euro CLO forecast of $3-5bn (€3bn+) to that and you have a global forecast of up to $75bn. 

Rishad Ahluwalia is head of global CLO research at JPMorgan