CLO volume this year has been a bright spot for leveraged loans, with nearly $18 billion in funds launching so far, according to Royal Bank of Scotland analysts.
And while CLOs have traditionally built a warehouse of loans before launching, many of the new vehicles have kicked off without being fully ramped, meaning they still have money to put to work.
Another piece of good news lies in the continuing strength of most subinvestment-grade issuers.
First quarter aggregate leverage remained flat quarter-over-quarter at 4.2x and has declined modestly year-over-year from 4.4x, according to Fitch Ratings. Declining leverage levels for BB rated issuers have started to flatten at 3.2x. Modest declines in leverage for B rated issuers have occurred at 5x (from 5.2x the year prior).
Stable credit profiles for most issuers should allow a buffer to withstand a prolonged period of weak economic growth, the rating agency said.
“We feel pretty good about fundamentals,” Rixam said. “Individual borrowers are still pretty strong. The macro-economic picture is clouded, but leverage levels and balance sheets are good. We believe you’re getting paid fairly well based on expected defaults.”
Highland Capital Management expects loans to returns between 0% and 3% in the second half; the firm sees loans besting junk bond’s performance, which it expects to range from a loss of 2% to a return of 1%.
This projection comes in part because of demand from new CLOs, and in part because loan fund flows are less volatile than bond fund flows, said Mark Okada, Highland’s chief investment officer. He cited large amounts of money moving in and out of high yield bond ETFs as a particular concern.
“If there are three or four weeks of consistent outflows from mutual funds and ETFs, high yield [bonds] could get hit pretty hard,” Okada said.