CLO ISSUANCE HITS HIGHEST LEVEL SINCE BEFORE FINANCIAL CRISIS / THE FINANCIAL TIMES

September 29, 2013 6:07 pm

 

CLO issuance hits highest level since before financial crisis

 

By Tracy Alloway and Nicole Bullock in New York

 

Sales of sliced-and-diced corporate loans have reached a fresh post-crisis record as investors clamour for higher returns from the structured financial products.

A spurt in sales last week has helped push US issuance of so-called “collateralised loan obligations” so far this year to at least $55.41bn, according to S&P Capital IQ LCD – the highest since the $88.94bn sold in 2007, just before the financial crisis.

The record sales will be cheered by bankers who had warned that the collapse of the CLO market after the crisis would leave companies unable to refinance their older loans and potentially spark a wave of corporate defaults. Many of the traditional buyers of CLOs – such as complex bank-operated special investment vehicles – went belly-up after 2008, causing issuance of CLOs to all but disappear in the following year.

 

But bundled corporate loans have enjoyed a comeback in the US as banks, pension funds and insurance companies seek ways to boost returns in the face of the Federal Reserve’s continued low interest rates. Europe’s market has been slower to revive, but Intermediate Capital Group, a London money manager, is preparing to issue a €500m collateralised loan obligation, the largest CLO there since the financial crisis.

 

CLOs package together “leveraged loans” issued by highly-indebted companies and then slice them into different pieces, or tranches. Investing in CLOs can give investors higher returns than placing their money in similarly-rated structured products, such as commercial mortgage-backed securities.

The amount of structured products held by US banks, including CLOs, jumped to $65.8bn at the end of June, according to FDIC data. That is the highest amount since 2009, when the FDIC breaks the figure out in its statistics.

However, the economics that underpin the deals may shift because the rules around these transactions are in flux.

The Federal Deposit Insurance Corporation began including US banks’ exposure to riskier assets, including leveraged loans and CLOs, when calculating how much the lenders should pay in deposit insurance, for instance. That move could decrease demand for the products from banks, which are said to have been some of the biggest buyers of the deals in recent years as they struggle to increase their profit margins.

 

But the head of the Basel Committee on Banking Supervision, which sets global rules for banks, told the Financial Times this week that the body might ease up on capital requirements for securitised products, which could have the opposite effect.

Finding buyers for the top-rated “AAA” tranche of the deal also remains a challenge for some CLO deals, bankers say. The top tranche is considered the safest for investors but it also yields the smallest returns. Many investors have focused their buying on riskier, lower-rated tranches with higher yields.

CLOs take advantage of the difference between the yield from investing in leveraged loans and the cost of funding. Early this year, the potential profits from this gap were very attractive, but loan spreads have narrowed as the funding costs of the CLOs rose.

“The crux of the issue is around arbitrage,” between the AAA tranches and the underlying loans the CLOs package, said Steven Miller, managing director at S & P Capital. “If the economics went back to where they were at the beginning of year, there would be more issuance.”

 

Copyright The Financial Times Limited 2013.