CLO market thaws

The primary CLO market at the beginning of April was bolstered by its first post-crisis issuance, a $525m structure from US-based investment group Sullivan Fraser. The deal signalled a thawing of the primary CLO market which had been a significant driver of private equity lending in the boom preceding the credit crisis. Although CLO products suffered equally at the height of the crisis, the secondary market - which focuses on repackaging and reselling of older debt - was the subject of significant interest late last year, as bargain hunters sought to take advantage of the deeply discounted prices.

This increased demand fuelled a price recovery in the secondary debt market. According to Chandrajit Chakraborty, managing partner at Pearl Diver, a London-based structured credit fund, senior secured loans that had plummeted to lows of 40 - 50 cents to the dollar in early 2009 are currently trading the in the 90s. However, this is a far cry from the pre-crisis era when similar loans would have traded at premiums of about 101-102 to the dollar.

Furthermore, with the significant price recovery in the secondary market, investors are now looking for good deals in the primary market. As Chakraborty explains, money managers and institutional investors that had fled the credit markets at the height of the crisis are now flocking back to the market in search of higher yield. The credit market has also been boosted by better than expected fundamentals: 2009 loan default rates for Europe and the US are hovering between 5% and 6% - significantly lower than the 18% to 22% predicted by rating agencies at the height of the crisis. However, Chakraborty warns that pricing needs to improve further for business to return back to normality.

"For the economics to work, we should be looking at pricing in the AAA tranches to reach levels of about 100 -125 bps," says Chakraborty. "Although prices on AAA tranches have come in from the extreme levels of up to 600-800 points at the height of the crisis, to current levels of 190-200 bps, this needs to come in further."

In the meantime, issuers are working to bring more structures to the market - with at least a handful of primary CLOs currently being marketed to buyers, according to industry sources. Private equity groups Blackstone and Apollo are also reportedly working on some deals, with analysts predicting that new issuance will hit $15bn in 2010. However, according to Jean-David Cirotteau, a securitisation analyst at Société Générale in Paris, the new CLO structures are set to be more basic.

"We expect the new CLO structures to be less complex, with fewer exotic tranches like PIK, and have assets with less leverage and possibly more covenants,"he concludes.

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