The European Collateralized Loan Obligation (CLO) market has seen a significant upturn in the first half of 2024, with issuance levels approaching the record set in 2021. This robust performance has led several major banks to adjust their annual forecasts. Deutsche Bank now projects €37 billion in European CLO issuance for the year, close to the €39 billion peak of 2021. Similarly, JPMorgan anticipates €30 billion, while Bank of America forecasts €27 billion in new deals, bolstered by an additional €12 billion in refinancings and resets.
Data from Creditflux shows a high level of new issuance in the first half of the year, with March and May each exceeding €5 billion in new deals. By mid-year, total new European CLO issuance reached €24 billion.
Several factors are driving this resurgence. Easing inflationary pressures have made credit markets more accessible, thereby enhancing the leveraged loan market and providing CLO managers with a steady supply of assets. The European Central Bank’s interest rate cut in June has further stimulated loan market volumes, despite the resulting compression of tranche spreads. The inherent leverage of CLO structures continues to perform well, with the interest rate differential between loan portfolios and CLO debt tranches offering strong returns for equity tranche holders, potentially ranging from 20% to 25%.
The European market is attracting new participants, including start-ups led by experienced portfolio managers and large US asset managers expanding into Europe. Additionally, family offices are establishing their own platforms.
The first quarter of 2024 saw the market’s first refinancing in two years, driven by narrowing spreads, especially for AAA-rated senior tranches, which fell from around 175 basis points in early 2023 to 125 basis points by late July 2024. Creditflux data confirms this trend, with reset activity picking up in March and April, reaching €710 million and €1.64 billion, respectively. Refinancing activity also showed signs of life, with €750 million recorded in May.
As the year progresses, experts expect a continued decline in tranche spreads, likely boosting both refinancings and resets. Refinancings, which involve repricing some of the CLO’s debt tranches at lower rates, are becoming more feasible as yields soften. Resets, which create new CLOs using assets from original deals, are also expected to increase due to the economic benefits of lower interest rates and tighter spreads for CLO equity holders.
While 2024 is shaping up to be a strong year, total volume is unlikely to match the exceptional levels of 2021, which were driven by post-pandemic recovery and significant monetary intervention. The unique conditions of that period, including dramatic interest rate reductions, created an environment that propelled CLO activity to unprecedented heights.
The European CLO market may also benefit from the EU’s focus on environmental, social, and governance (ESG) and sustainability legislation. ESG considerations are gaining importance due to regulatory developments and investor demand. Ursula von der Leyen’s re-election as European Commission President solidifies the EU’s commitment to its sustainability agenda, with the EU Green Deal set to expand its scope in the coming years.
The Corporate Sustainability Reporting Directive (CSRD), which began applying to public companies in 2024 and will extend to private companies in 2025, mandates detailed reporting on environmental impact, social responsibilities, and governance practices. For CLO managers, this means access to standardized ESG data on their portfolio companies, enhancing their ability to incorporate ESG into investment decisions and risk management. For investors, the CSRD will provide comprehensive ESG data, potentially broadening the investor base and driving innovation in CLO terms.
As the market adapts to new regulations, more CLOs marketed as Article 8 funds under the EU’s Sustainable Finance Disclosure Regulation (SFDR) may emerge. The availability of standardized ESG data through the CSRD is expected to facilitate this trend, making it easier for CLO managers to meet disclosure requirements.
These developments present challenges in terms of compliance and potential shifts in investment strategies but also offer opportunities. CLO managers who successfully adapt may attract ESG-conscious investors and benefit from the long-term stability that sound ESG investment practices can bring. This could serve as another catalyst for the European CLO market.
Though European CLOs may still lag behind their US counterparts, which currently have $1.07 trillion in assets under management, they continue to establish themselves as a highly attractive asset class for yield-seeking investors. With impressive momentum already gathered, the European CLO market looks set for a strong finish in the latter half of 2024.
The European CLO market’s strong performance in 2024, driven by favourable market conditions and regulatory developments, highlights its growing appeal to investors. Despite challenges, the market is well-positioned for continued growth, bolstered by ESG considerations and the adaptability of CLO managers. As the year progresses, the market’s trajectory suggests a robust finish, further solidifying its status as an attractive investment option.
Volta Finance Ltd (LON:VTA) is a closed-ended limited liability company registered in Guernsey. Volta’s investment objectives are to seek to preserve capital across the credit cycle and to provide a stable stream of income to its Shareholders through dividends that it expects to distribute on a quarterly basis.
