The CLOs conclude a record year
Investors’ search for higher yields and Wall Street’s shift to a new benchmark interest rate fueled record year of secured loan bond sales – securities made up of bundles of low-rated corporate loans .
Asset managers including Ares Management Corp.
and PGIM Inc. are set to end the year with more than $ 186 billion in new CLO sales, according to Leveraged Commentary & Data. This is a data record dating back to 2011, breaking the previous 2018 annual record of $ 128.9 billion.
The US CLO market is now the largest securitized credit sector in the country with an outstanding $ 850 billion, according to Bank of America Corp. student balances and loans.
CLOs have been one of the best performing credit assets this year, attracting investors looking for higher bond yields in a world where interest rates are close to zero. Improving corporate profits have helped keep default rates low on the underlying leveraged loans, which private equity firms use to fund company buyouts, analysts said. The CLOs are the biggest buyers of these loans.
One of the factors contributing to sales in the fourth quarter was the year-end transition of the London interbank interest rate, the scandal-tainted benchmark interest rate underlying CLOs and thousands of billions of dollars in other financial contracts. From January 1, banks will no longer be able to issue new Libor-linked debt, while outstanding debt will have until 2023 to switch to a new rate.
Higher than expected inflation has also made CLO stocks attractive to investors over the past year. Securities typically offer payments that rise and fall with interest rates, unlike fixed payments on many bonds, which increases the attractiveness of debt at a time when many investors expect rates to rise. .
AAA-rated CLO securities have returned 1.4% to investors this year through November, counting interest payments and price changes, according to Bank of America, beating total returns by minus 1.82% on bonds of the US Treasury and minus 0.96% of investment grade corporate bonds. . These securities are generally purchased by banks and insurance companies.
CLOs rated double B had a total return of 8.9% this year over the same period, outperforming 3.51% and 4.53% of high yield bonds and leveraged loans of the same rating. , respectively.
Some analysts believe that dropping Libor could slow the pace of CLO sales. Banks and lenders have come under pressure from regulators to reduce their and their clients’ exposure to Libor, which is being phased out after regulators discovered that traders at major banks had manipulated the rate by submitting bogus data.
But issuers of leveraged loans and CLOs continued to launch deals using Libor until the end of the year, saying it remained attractive for reasons such as favorable rates and familiar behavior, according to executives, lawyers and advisers.
Only a handful have sold securities linked to the replacement of Wall Street’s preferred Libor, the Secured Overnight Financing Rate, or SOFR.
The transition to SOFR could leave some CLO securities with different loan credentials in their collateral pool, analysts said. Loans sold before the year-end deadline may continue to reference Libor until 2023. This makes it more difficult for investors to protect their holdings against fluctuations in the rates and prices of the underlying loans, a phenomenon known as baseline risk.
Until that 2023 deadline, CLO managers will likely seek to minimize the risk between their assets and their funding, preferring to hold more Libor-based loans in old CLOs that pay Libor-linked investors and loans based on Libor. SOFR in the CLOs referring to SOFR.
After the transition, however, many analysts expect CLO sales to meet strong demand. Bank of America is forecasting around $ 155 billion in new sales next year, while Barclays PLC is forecasting between $ 135 billion and $ 145 billion. If either forecast comes true, that would make 2022 the second highest selling year on record.
“We might have a few slow weeks before 2022, but then I’m sure we’ll have deals made,” said John Kerschner, head of US securitized products at Janus Henderson. “The issue will remain robust and there will be more attention paid to this asset class.”
Write to Sebastian Pellejero at [email protected]
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