Wells Fargo has increased its forecast for issuance of U.S. collateralized loan obligations, largely based on expectations that banks will continue to be able to invest in these deals.
The bank now expects to see between $80 billion and $90 billion of issuance, according to a report published Tuesday. A previous forecast, published in early December, called for issuance of $60 billion.
The primary market got off to a slow start to the year, largely because the Volcker Rule, published in December, makes it difficult for bank to hold the senior securities issued by CLOs. Volcker prohibits banks from having “ownership interests” in securitizations of any assets other than loans. The creates two problems: most CLO have some exposure to corporate bonds, as well as loans, and the senior debt tranches of these deals have some equity-like characteristics.
Just $21.8 billion of CLOs were issued in the first quarter of this year, according to Thomson Reuters LPC. That was down 20% from the fourth quarter of 2013. However, the pace has picked up considerably, as that volume was heavily weighted toward February and March
Among other factors that Wells Fargo cited in its revised forecast are the “good relative value” and “a quality performance history;” the possibility of $40 billion - $45 billion in “runoff” as older CLOs pay down or are called; a large number of managers looking to issue deals; the possibility that “onerous” risk retention rules will take effect in 2016, which may push issuance forward; and “increased understanding and familiarity with many new regulations.”
The report also cited several possible headwinds to increase primary volume this year, however, including: “less market depth” compared with other sectors of the asset backed market, especially for triple-A rated securities; pressure on equity returns, specifically due to outsized retail demand for loans; and the resulting disconnect between spreads on senior CLO tranches and spreads on loans backing these deals.