CLOs

After a mixed start to Q4 for risk assets, Elena Rinaldi examines how European ABS and CLO assets have fared so far in Q4 and the factors currently affecting both markets.

Let’s not forget that the BoE dropped rates from 0.75% right down to 0.1% at the start of the COVID-19 pandemic back in March 2020, having only managed to put through two hikes in 2017 and 2018. It has changed course sharply before.

BWIC – or bids wanted in competition – lists, are a unique characteristic of the ABS and CLO markets, where they are widely used in secondary trading when investors are looking to sell bonds.

Based on these metrics, the picture seems rosy, and credit performance looks set to continue through the second half of the year should the main drivers of the recovery remain intact.

2021 looks set to become a post-financial crisis record year for European CLO issuance and refinancings, but amid the rush of activity we are seeing a concerning trend for weaker documentation in refinanced deals that in our view investors need to fight against.

I think it’s likely we’ll see new cycle tights for the European CLO sector this year, so in addition to healthy income we believe there is plenty of room for capital appreciation as prices are being pushed higher in the secondary market.

Our analysis indicates European ABS investors can carry forward little concern about nasty default surprises, and this is likely to be important when considering total returns for 2021.

Overall CLO and loan performance have exceeded our expectations, though there are still plenty of headwinds for the market, chief among which is the prospect of further lockdowns and more economic disruption as Europe battles a second wave of COVID-19 cases.

There are still plenty of potential bumps in the road (Brexit, the US election, COVID-19 developments and so on) but the positive technical created by dwindling supply has the potential to push spreads tighter in coming months.

We expect September to be relatively busy with new ABS deals, but there’s a very strong technical developing in favour of ABS and CLOs, which should help performance in the coming months.

If floating vs. fixed is no longer the most pressing question, then investors should be more focused on where they get the best credit spread.

In the past few weeks CLOs have become the focus of much attention, both from market participants and the media, especially following the negative rating actions that agencies have taken on the underlying loans as well as CLO tranches.