Many of the biggest whales in secured loan bonds are returning to the $ 900 billion market after spending much of last year on the sidelines, a change that could make it one of the largest distributors of credit in Wall Street even hotter.
From Japan Norinchukin Bank, formerly the biggest buyer in the CLO market, has started looking for deals again, according to people with knowledge of the matter. Wells Fargo & Co., out for much of 2020, is back. Fidelity Investments has already increased its holdings in search of higher returns. And Bank of America Corp., previously only an occasional buyer in the market, has bought billions of dollars in bonds and plans to add more.
The return of the big players is an important step in the resurgence of the CLO market, which had been in the doldrums for much of last year. Investor demand for these securities is reflected in an increased flow of money into leveraged loans, the commodity packaged in CLOs. This influx may help private equity firms fund more leveraged – and potentially riskier, buyouts. It helps business owners borrow extract dividends from their companies. It may also fuel the kind of excess corporate credit that regulators have warned about. for years.
But the CLOs came out of the pandemic without the massive downgrades that investors had feared, a performance that helped fuel renewed demand for them and their relatively high returns. Bank of America has a program in place to regularly buy top-notch CLOs, according to people with knowledge of the matter who are not authorized to speak publicly. According to a Morgan Stanley study, Bank of America had only $ 80 million in CLOs at the end of last year.
Norinchukin Bank, often referred to as Nochu, held $ 73 billion in CLOs at its peak, multiples of what any other institution had. But the bank has been largely absent from purchasing new CLOs since 2019, when Japanese authorities restricts purchases of instruments. The bank’s assets have been declining since the end of the year. That trend has accelerated this year because many CLOs have refinanced or reset their liabilities, and Nochu has often been replaced as an investor in the process, according to people familiar with the matter. A bank representative declined to comment.
JPMorgan Chase & Co. and Wells Fargo – which have long been among the biggest buyers of CLOs – have also increased their holdings this year, according to others with knowledge of the matter. (JPMorgan held $ 29 billion in securities at the end of last year, while Wells Fargo had $ 25 billion, according to Morgan Stanley.) Small banks, including PNC Financial Services Group Inc. and The Toronto-Dominion Bank has also increased its investments.
“The pendulum has changed dramatically,” said Lauren Basmadjian, head of US structured lending and credit operations at Carlyle Group Inc. “Many investors who were absent in 2020 have come back in size.”
Pacific Investment Management Co., Blackstone Group Inc. and Fidelity bought more instruments, according to people with knowledge of the matter. Pimco adds risk, moving from shorter-dated AAA bonds that made up most of its purchases in 2019 through 2020 to buying securities with a range of ratings, according to one. State Street Corp. also have started buying European CLOs.
Deploy repositories
Asset managers sold more than $ 108 billion of US CLOs in the first quarter, including refinances, resets and reissues, setting a new quarterly record. So far, many buyers who have increased their allowances have come from the United States.
For banks, demand is driven by the massive amount of deposits they received during the pandemic, as low interest rates have widened the money supply. Lenders in the U.S. banking system had $ 17.8 trillion in deposits at the end of December, an increase of more than $ 3 trillion from the same period a year earlier, according to data from the Federal Deposit Insurance Corp.
Much of this money is not on loan, forcing banks to invest in securities instead. Morgan Stanley research team led by Charlie Wu expects reserves to be held at the US central bank to increase by an additional $ 2 trillion this year.
“The big news is that US banks have stepped up and some have come back,” said Dagmara Michalczuk, portfolio manager at Tetragon credit partners. “It was the incremental and incremental purchases by new investors and returning investors that made the difference.”
Many investors are returning to the CLO market after being absent for much of 2020, when portfolio managers feared the pandemic would trigger a wave of downgrades for loans, decimate the value of the riskier parts of secured loan obligations. These rating downgrades never really happened, and now the economy is in recovery mode, resulting in more CLOs upgrades as downgrades.
Supply indigestion
The sheer volume of securities that CLO managers are currently producing, both from new sales and from refinancing existing transactions, appears to have overwhelmed the increased appetite of investors. Risk premiums on AAA-rated portions of CLOs, known as discount margins, edged up, averaging around 1.08 percentage point on Wednesday from 1.03 percentage point in mid-February, according to Palmer Square CLO data compiled by Bloomberg.
“The fact that the spreads are slightly wider and not significantly wider is really a testament to all the demand that has come about the Fed’s keeping rates low,” said Dave Preston, head of structured credit research at AGL Credit Management. .
Most market participants see this slowdown as a failure, and there is a bloat of the pipeline of transactions ahead.
“It’s pretty common to take a break and reassess at the end of the first quarter,” said David Moffitt, co-director of US credit management operations at Investcorp. “I don’t see this as a rotation out of the CLO asset class. I see it more as a break in the pipeline. “
CLOs continue to offer a higher yield than investment grade corporate bonds. A corporate bond rated in Level A, or four to six levels above the junk, on average represents a risk premium of around 0.7 percentage point, according to Bloomberg Barclays Index data, or about 0.38 percentage point lower than a CLO rated AAA. And CLOs tend to carry floating rates, which means their yields will rise as the Federal Reserve rises.
The strong issuance of CLO resulted in increased sales of leveraged loans. Companies have valued over $ 145 billion in leveraged loans in the first three months of 2021, including new loans and refinancings, the highest quarterly level since at least 2013.
In addition to Nochu’s planned return to CLOs, Japanese companies including Japan Post and Mizuho Financial Group Inc. are also continue to invest or increase their investments. Sumitomo Life Insurance Co.a started buying European CLOs recently, having previously focused primarily on the US securities market. The return of domestic investors to the market is a key variable in the strength of demand in the future.
“If Japanese banks get back into the fray, it will be a game-changer for AAA spreads,” said Nikunj Gupta, European CLOs manager for new issues at Deutsche Bank in London.
– With the help of Taiga Uranaka and Charles E Williams