“The true [difference] will likely be closer to 10 basis points, if not tighter, versus the 26,” said John Hwang, portfolio manager at Western Asset Management, adding there’s precedence from other markets that have already issued SOFR-priced transactions, and a deal now in the market launched its initial price talk with a 10 basis point adjustment to SOFR, in addition to the credit spread.
The wider the spread adjustment, the more it will erode the asset-liability arbitrage that fuels CLOs, potentially slowing the launch of new CLOs. And the uncertainty of how to price loans over SOFR could encourage further use of Libor this year.
“How robust issuance this quarter will really depend on how quickly we get through this price discovery stage,” Hwang said.
J. Paul Forrester, a partner at Mayer Brown, said the BSL market appears resigned to pricing loans over SOFR, rather than a credit-sensitive Libor alternative such as BSBY, at least for now, and his firm is internally training its lawyers to prepare for the pricing shift
“That’s been a major holdup in our market so far,” Wohlberg said. “Everyone knows that it’s closer to the spot difference today, and 26 basis points is not the right number, but no one is incentivized to be the first mover yet.”
Once the issue is resolved, he added, there might be a cascading effect in light of the record volume of loan issuance available to CLO bonds’ low default rates and attractive yields compared to other investment products.
“Even if there’s some sort of short-term lag in figuring this out, as we hit that bright line at the end of the year or maybe even several weeks before that people will solve the issue, because the volume and demand are there,” Wohlberg said. Continue reading →