As is often the case when looking into the future, we have some good news and some bad news regarding the leveraged loan market in 2010. The bad news, though hardly a surprise, comes in the form of returns - much lower ones. The good news is the expectation that primary issuance will jump, with some market participants portending the return of the CLO.
According to Barclays Capital estimates, U.S. institutional loan volume should hit somewhere between $70 billion and $80 billion in 2010. And analysts at Bank of America predict total U.S. leveraged loan volume will reach as high as $106 billion.
The majority of this new money will be used by companies looking to refinance their debt and make acquisitions, market participants say. However, the new-issuance market could see a lot of activity from companies coming out of bankruptcy with large exit facilities.
The Bank of America analysts also expect to see roughly $15 billion in new money flowing into CLOs. "There is good chances of seeing the CLO primary re-emerge in the future," said the analysts. "Its new form is likely to be different from former structures, particularly with respect to leverage."
In 2009, several encouraging signs began to emerge from the CLO market. A couple of new deals were done late in the year, while metrics, such as OC tests, improved for a number of CLO managers.
Analysts at Wells Fargo believe there could be between $3 billion and $6 billion in new CLOs in 2010, while analysts at JPMorgan Securities think that number will be around $5 billion.
"There is a considerable amount of talk in the market regarding potential for new CLO issuance," said Michael Khankin, the director of structured credit portfolio management at NewOak Capital. "Clearly CLO managers, bankers, traders, current CLO investors, and, less directly, the loan issuers themselves want to see this market recover."
Wells Fargo grabbed the market's attention right before Christmas by pricing a $275 million CLO that focuses on loans made to midmarket companies.
"That deal was static and short - a balance sheet financing for a player with limited direct access to the capital markets," Khankin said. "So are new CLOs wishful thinking? Given the massive rally in loan prices this year, with many loans trading in the 80s and 90s, yields are not significantly wider than the secondary 'AAA' CLO spreads, making such financing uneconomical. And unless you have some really cheap loans, the CLO liabilities are generally trading at a discount to the portfolio after taking fees and expenses into account. So until 'AAA' spreads come in another 100 to 200 basis points relative to loans, we shouldn't expect to see a deluge of issuance."
Yet some market participants say the CLO market has some secret gadgets under its hood.
"I wouldn't be surprised if we see a private market develop for CLOs, where someone has some equity and finds a big lender or provider of the triple-A-rated paper and they strike a deal on their own," said an analyst at an industry trade group. "These structures will include many of the indentures you find in CLOs today - WARF tests, interest coverage tests, etc. - but it will be done on a privately negotiated basis and perhaps without the involvement of the rating agencies."
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