The recovery in the average bid price in the European leveraged loan market since October last year may be more technical than it seems, supported by ramping collateralised loan obligation (CLO) vehicles and a shortage of viable supply in the primary market. Until we see a stronger flow of new buyout deals, it remains difficult to say whether the rebound over the last five months is sustainable and how the arbitrage will begin to work for new CLO creation.
The European Leveraged Loan Index (ELLI) has climbed out of the doldrums after hitting its lowest level since the pandemic in the fourth quarter of 2022. The average weighted bid for loan paper troughed at 88.13 points in October of last year, but as this week’s Chart Room shows the index has since steadily recovered, stabilising at 93.13 on March 22 even after a week of some softness following the takeover of Credit Suisse.
This rebound is reassuring but may not prove as robust as it first appears. The sharp demand for senior secured loan paper we’ve seen since October last year has not been matched by supply from the primary market, and it is this technical bid that has been pushing the levels in the index higher.
Over the quarter to March 14, some €5.9 billion (US$6.4 billion) of new collateralised loan obligations (CLOs) were completed from 16 deals, broadly in line with volumes seen in the fourth quarter of last year1. By contrast, leveraged loan primary market supply has fallen with only €7.55 billion of issuance completed in the first quarter to March 21, down from €12.65 billion in the last three months of 2022 according to data provider Leveraged Commentary & Data. Although CLOs are not the only investors in the loan market, they are the largest bidders and make up around 60 per cent of buyers in Europe. This quarter, the relative scarcity of supply in the primary loan market has pushed CLOs to bid up prices in the secondary market, buoying the index somewhat artificially.
This recovery though may be vulnerable. During one week late in February, press reports noted that six funds launched formal requests for bids on a package of securities known as Bids Wanted in Competition, or BWICs2. This only brought between €500 million and €600 million of new supply to the market, but still the secondary market sagged under the weight, with the average bid price in the ELLI falling to around 93.92 at the end of the month from its 2023 high of 94.36 on February 9.
For the moment, there is little hope that a larger level of supply will come through the primary market. Deals have evaporated. There was only €3.9 billion of issuance to finance M&A in the first quarter of the year – the lowest quarterly volume for these deals since the final quarter of 2012 according to LCD – and with a mismatch in the valuation expectations of private equity buyers and sellers continuing, few expect the pace of leveraged buyouts (LBOs) to pick up in the first half.
Today, CLO arbitrage looks challenged and whilst the recent volatility from the banking sector has provided a degree of softness, we still need to see secondary pricing step back to pave the way for new CLO creation. Whilst there is market talk of 50 CLO warehouses being open, it is understood that the vast majority have very few assets already acquired. Given the current secondary pricing backdrop and absence of primary transactions, ramping these vehicles to completion could be challenging.
Sources:
2. BWICs weigh on European secondary loan levels, Leveraged Commentary & Data, Feb 24 20
