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CLO market faces strain from Japan investor scrutiny, UBS Says

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Heightened regulatory scrutiny of Japanese’ banks exposure to collateralized loan obligations could weigh on the sector for some time to come, according to UBS Group AG.

“Our conversations with Japanese investors suggest our initial interpretation of the regulatory intervention on Japanese CLO investments was too benign,” UBS credit strategist Matthew Mish wrote in a note published on Thursday.

Japan’s financial regulator is examining banks’ holdings of bundled leveraged loans as they pile into the products in search of yield. Lawmakers have also begun grilling government ministers on risks tied to CLOs investments by the biggest buyer, Norinchukin Bank, which has been ramping up purchases of the highest-rated securities.

“The regulatory scrutiny, political risk and broader exposures appear to be bigger than we initially believed, implying the widening in AAA CLO spreads may not retrace soon,” Mish wrote. UBS is also concerned about “stealth deterioration” in fundamentals of U.S. leveraged loans.

Norinchukin is scheduled to release fresh figures on its CLO holdings next week. The agricultural bank held 6.8 trillion yen ($62 billion) of collateralized debt obligations as of December, almost all of which are assumed to be CLOs.

Bloomberg News