News Analysis

Deals reset middle-market expectations

Monday 4 September 2017 14:39 London/ 09.39 New York/ 22.39 Tokyo

Middle-market CLO issuance has picked up again, following a summer lull, and spreads have ground tighter. Investors will be keeping an eye on how tight spreads get, and also on the risk of credit issues as competition for assets intensifies.

When TCP Whitney CLO 2017-1 priced at the start of August it did so at the tightest triple-A spreads for a middle-market CLO all year. A week later, MCF VII CLO followed at spreads that were tighter still.

Madison Capital Funding's US$302m MCF VII CLO brought middle-market CLO issuance for the year up to US$8bn across 14 deals (see SCI's primary issuance database). The triple-A and triple-B minus DMs were 160bp and 410bp, which were the tightest levels of the year for a middle-market CLO.

Tennenbaum Capital Partners' slightly larger US$350.85m TCP Whitney CLO 2017-1 priced its triple-A notes at 168bp. The triple-B rated C class priced at 413bp. While both MCF VII CLO and TCP Whitney CLO 2017-1 represent significant landmarks for the middle-market CLO space, their welcome reception owes a debt to a previous transaction, issued back in April.

"There is more interest in middle-market CLOs now than there has been at any time since the financial crisis. That is largely thanks to the Antares CLO 2017-1 transaction, which was a real game-changer for the market," says Oliver Wriedt, co-ceo, CIFC Asset Management.

He continues: "What we see now is a market buoyed by relative value. Antares was massively over-subscribed and shows what can be achieved when you have a Tier 1 originator. The success of Antares has nudged platforms to consider funding more of their middle-market loans through securitisation."

The flurry of activity in middle-market CLOs has not only caught the attention of platforms, but also of rating agencies. The TCP Whitney CLO 2017-1 deal which reignited issuance also brought DBRS more squarely into the traditional syndicated CLO market, with the rating agency joining S&P in assigning a triple-A rating to the senior notes.

"DBRS typically rates warehouse and more bespoke CLO structures, but we are increasingly involved with more syndicated CLOs. That is a natural progression for us, because as we are already working with arrangers and asset managers on warehouse facilities and they are familiar with how we work then it makes sense to take that next step," says Jerry van Koolbergen, head of structured credit, DBRS.

The middle-market space has been split between traditional syndicated CLOs, which have the higher leverage, and warehouse facilities, which are more bespoke. DBRS has previously been focused on the warehouse side of that split and van Koolbergen notes that there is still a lot of activity there, but that the rating agency also sees increased opportunities to rate syndicated CLOs.

He says: "There has been a lot of activity in the middle-market space this year, it is just that it has not all been in syndicated CLOs. I think we will see more middle-market CLOs before the year ends, but there will be plenty going on away from syndicated CLOs as well."

Van Koolbergen adds: "There are more CLOs in the pipeline and arrangers will be looking to test the boundaries. I understand banks are keen to get deals issued at even tighter levels."

Those future deals may well bring with them structural innovations. While TCP Whitney CLO 2017-1 was a largely standard deal, it did include a combination note, which is fairly unusual.

S&P rated that combo note, backed by the US$8.5m class B notes, US$4m class C notes, US$7.5m class D notes and US$5.55m subordinate notes, at triple-B minus. DBRS' van Koolbergen comments: "We have not seen a huge inquiry for combo notes in the middle-market space, but they are often useful for insurance companies so we may well see more in the future."

With or without further structural tweaks, all eyes will also be on senior spreads. The progressive tightening seen so far could continue and it will be interesting to see how successful arrangers are in pushing those boundaries.

"Broadly syndicated CLOs continue to be well bid, but there is room at the triple-A level for middle market CLO spreads to tighten even further. Many triple-A buyers tend to favour a buy-and-hold strategy and they know that the risk of taking losses at the triple-A level is very remote," says Wriedt.

While rallied liability spreads currently make the securitisation route much more cost-efficient for issuers, there is a chance that spreads might become too tight for investors. That remains a function of alternatives, of course.

"Right now 10-year CMBS, which is a common comparison, is trading well inside the CLO market. Most securitised products are nowhere close to where CLOs are. To realise greater yield an investor would have to move into the more esoteric asset classes, which stops being a straight-forward comparison," says Wriedt.

One other thing for investors to watch out for is the high level of competition for middle-market assets. While the market is currently healthy, van Koolbergen notes that there are good reasons to be cautious.

He says: "While the economy is doing well and there are plenty of reasons to be positive, it is also worth keeping in mind that this high level of competition could bring trouble further down the line. We are paying attention to the possibility of future credit issues and are aware of the number of new investors in the market."

04/09/2017 14:39:28