(Bloomberg) — If you listen to people in the trenches, the collateralized loan obligation market is having a great year.
The amount of bonds outstanding is now approaching $1 trillion globally, according to JPMorgan Chase & Co., after defying doomsday predictions made during last year’s economic slump, according to attendees at IMN’s virtual CLO industry conference this week. CLOs hold compelling value in every ratings tier, which may bring in more investors as yields dwindle in other parts of credit markets, said Chris Saltaformaggio, a CLO investor at New York Life Investors.
The deals, bundles of junk-rated leveraged loans that are packaged into slices of varying risk and return, have performed “as advertised,” panelists said, weathering setbacks last year due to the pandemic and even bouncing back and flourishing to new heights. The rebound comes after CLOs were deemed too troubled for even the Federal Reserve’s stimulus to help.
Sales are on track for an annual record, with Bank of America Corp. forecasting $360 billion of U.S. CLO issuance this year alone. That estimate includes $140 billion for new issuance and $220 billion for refinancings and resets of older deals. U.S. CLOs outstanding are now more than $700 billion, panelists said, while the European count is close to $186 billion.
“Human bandwidth is a real issue in our market,” especially as June and July are going to continue to be busy months, Saltaformaggio said.
A Household Name
CLO sales have reached more than $62 billion for new-issue U.S. transactions so far in 2021 — that’s 158% higher compared to the same period in 2020 — and over $107 billion of combined refinancings and resets, according to data compiled by Bloomberg.
“CLOs are becoming more of a household name; they’re more institutional now,” and are appearing as a staple in many diversified fixed-income portfolios, said panelist Ronnie Jaber, portfolio manager and head of structured credit at Onex Credit Partners. “Investors are seeing there’s real value here, tested through multiple downturns, and depending on their risk tolerance they can make money throughout the capital stack.”
Other factors have helped the rebound. For instance, the largest U.S. banks have re-entered the market, especially in the senior portions, and the critical Asian-investor presence has returned as well, panelists said.
The number of AAA investors has increased this year, which has been healthy for price discovery, according to Jim Stehli, managing director at Mizuho Securities, speaking at a Wednesday session.
The CLO market has also been buoyed by higher demand for floating-rate debt as many market participants expect rates to continue rising, which makes fixed-rate securities less attractive. Last year the market was helped by support from the Fed to the riskiest companies — those that issue leveraged loans — as well as portfolio managers trading out of perilous credits, protections built into the deals and a lower number of loan defaults than anticipated.
Not only do CLOs still appear cheap to other fixed-income sectors such as corporate bonds, but relative value opportunities can be found up and down the capital structure itself, the panelists said.
While speakers found CLO equity and mezzanine bonds the most compelling at the moment — with BBs the favorite among investors — some, including New York Life’s Saltaformaggio, are finding risk-adjusted spread in AAAs and AAs too.
“So basically you’re walking into a candy store where all the candies have high nutritional values,” said panel moderator Ann Rutledge, CEO of CreditSpectrum Corp., summing up the numerous CLO investing opportunities discussed by the speakers.
CLO equity is the “sweet spot” and “equity returns are phenomenal,” said Ujjaval Desai, head of structured products investing at Sound Point Capital. “We see significant arbitrage in the deals now, driven by leveraged loans having a Libor floor. The cash income coming into CLO structures now is huge.”
Laila Kollmorgen, a CLO portfolio manager at PineBridge Investments, prefers CLO equity to other types of private credit and direct lending because it’s more diversified and there’s a higher level of liquidity. PineBridge likes CLOs across the whole capital stack, with the current sweet spot being BBs, she said on the Thursday panel. However, “each CLO is idiosyncratic,” she warned.
As for what challenges may be on the horizon, panelists are concerned about inflationary pressures on businesses, and are keeping an eye on too much growth and government stimulus, which will be problematic if a struggling company’s costs can’t adequately be passed on to consumers. The spectre of so-called “zombie companies” is real, and even if a handful of credits ultimately blow up, that may affect CLO equity and BB classes, panelists said.
Another concern is that valuations across fixed income are extremely stretched right now. A shift in equities or high-grade credit could ultimately put pressure on different parts of the CLO, Saltaformaggio warned.
CLOs still “reasonably attractive” and equity remains a top trade along with short duration mezzanine, according to Rishad Ahluwalia, head of global CLO research at JPMorgan, speaking on a Wednesday panel at IMN’s virtual CLO conference
“CLOs are a unique product; they’re just different animals,” said New York Life’s Saltaformaggio. “Whether it’s because they’re actively managed portfolios, or their callability structure, uncertain weighted average lives, negative convexity, or constant negotiating of documents, those things just don’t really exist elsewhere in fixed-income areas, even in other securitized credit sectors.”
ABS deals in the queue include AG Resource Management (crop loan ABS) and Thrust Engine Leasing (aircraft ABS).
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