Key Takeaways:
- CLO managers struggle to find new leveraged loans due to a $1 trillion decline in M&A activity.
- Demand for AAA CLO tranches surged, compressing spreads by over 100 basis points since late 2022.
- Managers turn to corporate bonds to maintain returns, predicting fewer new CLO issuances.
What Happened?
The $1.3 trillion collateralized loan obligation (CLO) market is experiencing a supply-demand imbalance. Managers can’t produce bonds fast enough to meet investor appetite, driven by a slowdown in mergers and acquisitions (M&A).
So far this year, only $311 billion in M&A deals have been completed, a stark contrast to the $1 trillion recorded two years ago. As a result, about 60% of loans now trade above par, limiting bargain opportunities for CLO portfolios.
Why It Matters?
This imbalance could soon affect the equity arbitrage for CLO managers, potentially reducing new issuances. Pratik Gupta from Bank of America highlights, “There’s too much demand for CLO bonds and too little loan supply.
CLO managers can’t keep up much longer.” Investors are piling into the safest CLO tranches, causing spreads on AAA debt to compress by more than 100 basis points since late 2022. Despite an 86% increase in new CLO bond sales this year, investor appetite remains unsatisfied.
What’s Next?
CLO managers are increasingly turning to corporate bonds to maintain returns. Christina O’Hearn from Pretium Partners anticipates continued refinancing and reset activities but expects fewer new CLO issuances. Barclays Plc forecasts a 20% growth in M&A volume over the next 12 months, potentially easing some supply constraints.
However, the rise of private credit could continue to limit opportunities for leveraged loan lenders. Investors should monitor these trends closely as they could significantly impact future CLO performance and market dynamics.
