The slower paceof CLO issuance in the first quarter of the year did not hold back the overall market for below investment grade loans that back these deals, according to Thomson Reuters LPC.

Isuance of collateralized loan obligations totaled $21.8 billion in the first three months of 2014, a 20% drop from the same period of 2013, according to a quarterly report on leveraged lending published Tuesday.

A major catalyst for the decline was the uncertainty over whether banks would be forced to divest large quantities of CLO holdings due to the Volcker Rule, published in December. However, in recent weeks, issuance has been picking up again as participants gain confidence that there will be some kind of a workaround to the rule or that the requirement might be dropped.

The Volcker Rule prohibits U.S. banks from having an ownership interest in securitizations backed by anything other than loans. The rub for CLOs is that these instruments typically include high-yield bonds in order to jack up returns for investors. Despite industry opposition to Volcker’s treatment of traditional CLOs, the requirement has so far remained.

Spreads on CLO triple-A tranches remain in the ballpark of 150 basis points as some players have managed to follow the rule by, for instance, using second lien loans to juice returns. 

In contrast to the regulatory obstacle, the availability of raw material doesn’t appear to be an issue for CLOs.

Leveraged loan issuance rose 7% in the first quarter of 2014 from the last quarter of 2013 to $276 billion. While down from a year ago, it still ranks as the third-highest volume on record since 1987.

The quarterly rise came as companies looking to cut costs and extend maturities continued to flock to hungry investors eager for more attractive yields. The volume of leveraged institutional loans was also the third-highest on record at $168 billion, as was the $94.8 billion in covenant-lite loan volume in the quarter.

High yield-bond issuance was also down 22% from last year’s first quarter results, to $69.88 billion from $90.14 billion. Before the Volcker Rule, these instruments were often dropped into CLOs in order to boost the overall yield.

The first-quarter leveraged loan volume was below last year’s first quarter figure of $307 billion and far below the record $354 billion in the second quarter of 2013. Refinancings drove the bulk of first-quarter leveraged lending activity of $180.5 billion, which was up 22% from the fourth quarter of last year and was the third-highest mark on record for refinancings.

Conversely, merger & acquisition-related lending is down 22% from the previous quarter, to $59.6 billion. Thomson Reuters LPC cited a “small albeit steady” pipeline of $1-2 billion deals that kept the market under-supplied. Only 24% of $124 billion in sponsored lending in the quarter was slated for M&A activity, with the remainder of activity devoted to refinancing and dividend recapitalizations, according to Thomson Reuters.

Investors Push Back

While many of the figures seem to indicate that issuers continued to hold most of the cards in the market, Thomson Reuters noted a few signs have emerged that investors are pushing back against aggressive terms and pricings from speculative-grade issuers.

With many accounts fully invested and sitting on a lower, fixed pool of cash, according to Thomson Reuters, investors were “relieved of some of the pressure to invest.”

“It has mainly been around the edges but it seems the market is showing a little bit of discipline,” according to an unnamed underwriter quoted in the report. 

Another underwriter said that accounts “do not have unlimited amounts of liquidity and are picking their spots better despite the lack of M&A.”

Downward flexes on loans continued to hold sway, as loan yields fell 26 basis points for non-investment grade, single-B rated companies, while the yields of double-B issuers fell 57 basis points to 3.5%, per Thomson Reuters.

The increase in lending was driven by loans syndicated to institutional investors, which rose 24% from the fourth quarter to $168 billion. This offset an 11% drop in loans syndicated among banks, known as pro rata loans. However, pro rata lending was still the fifth-highest level since 1987 at $108 billion.

Despite concerns that deal flow could be impacted by efforts by federal regulators to discourage banks from lending to highly leveraged firms, the average total leverage level for large corporate leveraged buyouts was 6.24x in the first quarter. That was down slightly from 6.47x in the fourth quarter 2013 but “in line” with the 2013 average of 6.21x, according to Thomson Reuters.

The trend shows no signs of abating with “6-7.5 times leveraged LBO deals currently in market,” wrote Thomson Reuters.

Thomson Reuters LPC’s survey of lenders showed that many expect the tenor extension trend to continue as issuers was to “get ahead” of banks’ Basel III regulatory edicts.

JPMorgan was the leading leveraged bookrunner with 175 deals worth $39.6 billion to earn a 17% market share. Bank of America Merrill Lynch was second with 163 deals worth $33.3 billion (a 14% share) followed by Wells Fargo & Co.’s 77 leveraged deals covering $37.2 billion to carve out an 8% market share.

Citigroup was the lead bookrunner on CLO first-quarter issuance, with eight deals totaling $3.6 billion, followed by Morgan Stanley at $3.3 billion and five deals.

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