CLO surge prompts regulatory concerns
By Tracy Alloway in New York
Sales of bonds backed by riskier US corporate loans have surged to their highest level in seven years, helping to fuel a leveraged lending boom that is concerning regulators.
So-called collateralised loan obligations, or CLOs, have staged a striking recovery in the years since 2008, when securitised bundles of sub-prime mortgages were blamed for inflating the housing bubble and exacerbating the ensuing financial crisis.
Bonds backed by home mortgages not guaranteed by the US government's housing financiers have since largely disappeared, but sales of CLOs comprised of leveraged loans made to low-rated companies are poised to overtake levels last seen in the 2006-2007 credit boom as investors look for higher-yielding assets and companies take advantage of low borrowing costs.
Some analysts predict this year's issuance volume could eclipse the record US$97bn worth of deals sold at the height of the credit bubble back in 2006. On Friday, analysts at JPMorgan Chase increased their forecast for full-year sales from US$90bn-US$100bn to US$105bn-US$115bn.
The move followed an unusual flurry of CLO deals in August that helped push year-to-date issuance to US$85.4bn, easily surpassing the US$82.6bn sold in all of 2013, according to data compiled by S&P Capital IQ.
CLOs "are like the overflow markets of the structured product world", said Chris Flanagan, head of US mortgages and other structured finance research at Bank of America Merrill Lynch. "There is appetite for CLOs given the lack of production in the residential mortgage market."
Strong sales of esoteric products have helped boost investor appetite for leveraged loans just as regulators are warning about potentially overheated credit markets.
The Federal Reserve and the Office of the Comptroller of the Currency last year issued new guidelines to attempt to curb the riskiest leveraged lending undertaken by banks. The move appears to have had little impact on the overall loan market so far, however, with the leverage embedded in many new deals exceeding the amount recommended by rulemakers.
Leveraged loan issuance stands at US$404.7bn so far this year - slightly below the US$424.4bn sold in the same period last year, but still at hefty historical levels.
Meanwhile, CLOs now boast a record 55 per cent ownership of the total leveraged loan market, according to S&P Capital IQ - up from 48.2 per cent back in 2006.
"Borrowing costs are low right now so people are taking full advantage of that to get loans and get them funded through the CLO market," said Mr Flanagan.
The Loan Syndications and Trading Association (LSTA), an industry group, cautioned that many of the CLOs brought to market were being used to refinance older deals rather than fund new buyouts.
The structured products also face a flurry of new rules, including one that will require banks and other financial institutions to hold a slice of CLOs they create.
"Certainly US [CLO] managers are doing deals while they can," the LSTA said in a bulletin published late last week. "But there's also a decent amount of refinancings and redemptions."
In Europe, sales of CLOs have similarly surged to a post-crisis high of €8bn so far in 2014 - though issuance is still far below the €35.5bn peak sold in 2006.
Analysts have been debating whether this week's announcement that the European Central Bank plans to purchase certain types of asset-backed securities, a type of securitisation, will help revive the local CLO market.
The "ECB's emphasis on 'simple and transparent' [ABS] will likely create winners and losers, as certain sectors such as CLOs and CMBS [commercial mortgage-backed securities] will most likely be left out of purchases", Citigroup credit strategists wrote in a research note.
(c) 2014 The Financial Times Limited