US CLOs – Glut of issuance causes CLO mezz to soften

There has been a massive amount of supply in US CLOs this year, with volumes reaching $99.53 billion in the first quarter, versus $40.93 billion in Q1 2020. However, Chakraborty says the secondary market offers value when it comes to CLO debt. “At the moment, the secondary market provides better risk-adjusted returns, along with the flexibility to choose an appropriate price point and return target,” he says. “In the CLO equity market, the absence of bids — or sometimes non-economic bids from affiliated capital — makes the risk-return dynamic in the secondary market far more evenly balanced.” For relative value between tranches, Chakraborty says triple As have probably run their course, with any further increase more likely to be in issuance volume rather than price. But there are opportunities in junior mezz. “We are bullish on CLO mezzanine tranches where there has been somewhat of a step back in March and there is still scope to tighten from here on,” he says. Despite an influx of investors and CLO paper, it is unlikely there will be significant changes in the structure of CLOs given how well their structures have worked in the past, but Chakraborty sees scope for change around the fringes. That could be through allowing equity investors to buy restructured paper, taking into account any rating agency changes, or accommodating new Libor language. All of these are likely to become part of every CLO.