Kartesia sees spreads tightening slightly across capital structure throughout the month

The CLO market demonstrated continued strength in July, with spreads tightening slightly across the capital structure, according to Kartesia, a European specialist provider of capital solutions. 

“Euro CLO triple-A spreads closed the month 2.5bps tighter in secondary, and 7bps in primary at DM+97.5/DM+130, respectively,” say head of CLOs Michael Htun and structured credit associate Panagiotis Dounavis in the firm’s monthly structured credit update. “Euro CLO tranches in general have had a strong 2024 with YTD total returns on triple-B/double-B tranches of 7.1%/9.8%.”

However, the start of August brought a brief period of volatility, triggered by weaker macroeconomic data, leading to a sell-off in global equities.

“The VIX index (commonly known as the Wall Street fear gauge) briefly hit its highest level since 2020, before quickly retracing. Equity coupons remain elevated with July payments averaging 18.42% (on par) on an annualised basis for the 2013-2022 cohort. This is down from 21.64% in April 2024 but above expectations for the quarter.”

Average key performance indicators (KPIs) for the CLO market showed some signs of deterioration this month but remained generally healthy, according to the update. 

The primary driver of collateral underperformance was Intrum, which was classified as a distressed exchange by two major rating agencies. Consequently, their bonds are now treated as defaulted obligations, marked at the lower of market price or rating agency recovery rate. Additionally, IGM Resins completed its restructuring, moving from the defaulted basket to the triple-C basket.

Despite these challenges, the market's cushions remain robust, with the average interest diversion test (IDT) cushion only declining by 5bps to 3.60%. 

This test must be triggered for equity cash flow to be diverted. Managers were also proactive in reducing portfolio risk by selling underperforming credits in July, leading to a decrease in average par build from -0.80% to -0.97% month-on-month (MoM), Kartesia notes.

Furthermore, S&P updated its global CLO default study last month, highlighting that European CLOs had a cumulative default rate of just 0.4% from 2001 to 2023, with speculative-grade tranches recording cumulative defaults of 1.5%.

In terms of European primary CLO issuance, July saw 11 new issues price, with total issuance (including resets and refinancings) up 312% YTD versus 2023. 

Total CLO cost of funding has continued to come down throughout the year, from 242bps in January 2024 to 198bps last month, Kartesia states.

Ramla Soni