Despite potential regulatory hurdles and dire reports on the decreasing quality of underlying assets in collateralized loan obligations, structured credit experts said they see almost no letup in investor demand for CLOs in the foreseeable future.
Echoing recent forecasts that project another banner year for CLO issuance, several investment leaders speaking at a CLO investor conference Tuesday saw nothing standing in the way of new issuance totaling between $60-70 billion in 2014—even with a near standstill in the market in January when investors fretted over the potential impact Volcker Rule compliance would have on bank CLO holdings.
“It’s eminently doable,” said Amit Roy, vice president and head of CLO structuring for Goldman Sachs, during a CLO investor conference Tuesday at the New York Marriot Marquis that was hosted by the Information Management Network (IMN).
The panelists cited the increased demand from AAA-seeking investors like pension funds putting more into the market, as well the surge in first-time issuers from smaller, independent firms taking a stab at CLOs. They also cited investor confidence in the stability of CLOs, in contrast to the warning bells from regulators and media reports that have drawn the ire of the likes of Babson Capital Management chairman and CEO Tom Finke.
“The good news is the continued press has not caused these new investors to shy away from participating in the AAA market and CLO market,” said Mary Katherine DuBose, a managing director at Wells Fargo. “The statistics and historical performance will continue to show that the asset class has performed irrespective of where covenants may be going and where leveraged loans may be going.”
Algis Remeza, a senior vice president at Moody’s Investors Service, said that several credit factors have made CLOs favorable. He cited a speculative-grade default rate of only 1.71% in the past year, with projections to remain well below the 4.7% historical average since the 1980s. In addition is the strong market liquidity that has spurred a leveraged loan refinancing binge (and aiding default risk through lower rates), and a long track healthy track record of CLO performance, in which less than 2.5% of all tranches of CLO assets have become impaired since Moody’s began rating them.
CLOs, both the 1.0 pre-crisis vintage and the more recent 2.0 CLO portfolios, also both remain over-collateralized, Remeza said. In addition, “there are other factors driving new issuance,” he said, from the development of CLOs tailored to new investors, new managers wanting to try their hand at CLOs, and “even risk retention rules that may motivate investors to issue CLOs before rules come into effect.”
Another factor is, simply, cost. “CLOs are cheap,” said Oliver Wriedt, co-president of CIFC Asset Management. “I think it’s the only way to explain this tremendous volume that we’ve seen yet again.” Even with the slow start to the year, Wriedt said his firm is ahead of last year’s pace in both number of deals (five more than year-to-date 2013) and in volume (up $2.7 billion). New issuance is the driver, but in terms of value, CIFC is keeping its eye on the secondary trading market for loans that, “CLO issuance notwithstanding” are underperforming on a total return basis, he said.
“We anticipate there will be buying opportunities in the secondary,” said Wriedt, “where we can begin to build portfolios not just around aggregating new-issue collateral, but really take advantage of some volatility in the secondary market, perhaps for first time since the summer of 2011.”
Goldman Sachs’ Roy says that most market participants are holding a “bullish” short-term outlook on credit, but he does see signs of new issuance demand dissipating with AAA spreads “beginning to compress” and the Volcker Rule still overhanging the market.
Earlier this month the Federal Reserve announced that it was extending the compliance deadline for bank CLO holdings until 2017, allowing institutions additional time to shed more than $70 billion in covered funds assets they are prohibited from holding mostly notably the unsecured bond portions of the portfolios.