CLOs Issued Before 2008 May Fall to $72 Billion, JPMorgan Says

The market for collateralized loan obligations raised before 2008 may be cut in half in the next three years as funds exit their reinvestment periods and begin to pay down debt, according to JPMorgan Chase & Co.

The volume of so-called CLO 1.0 deals may fall to about $72 billion by 2016 or 2017 as almost all funds raised before 2008 exit the period in which they can buy new loans by 2014 and begin to amortize, the bank said in a Sept. 13 report. About $145 billion of CLOs, or 47 percent of the outstanding market, were issued in 2006 and 2007.

CLOs have historically been the largest buyer of U.S. leveraged loans and the decrease in outstanding deals may create a shortfall for corporate financings unless other types of loan investors, including mutual funds and hedge funds, grow “substantially” over the next few years, according to the report. There have been $64.1 billion of CLOs raised globally this year, $58.1 billion in the U.S.

This shrinking CLO market is “a cautionary tale of declining credit capacity,” JPMorgan analysts led by Rishad Ahluwalia wrote in the report.

CLOs were the largest buyers of leveraged loans in the second quarter, with a 53 percent market share, according to a report from the Loan Syndications and Trading Association, citing Standard & Poor’s Capital IQ Leveraged Commentary & Data. Retail loan funds were the second-largest buyer with 33 percent.

Global Deals

JPMorgan estimates the outstanding global CLO market is $416 billion, including $304 billion of U.S. deals, according to the report.

CLOs are a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and returns.

All of the $130 billion CLOs raised since 2008 will exit their shorter reinvestment periods, typically three to four years, during 2016 and 2017, and also begin to pay down debt according to the report.

Even with the assumption of $75 billion of volume in both 2014 and 2015, the entire U.S. CLO market will be about $200 billion by 2020, according to the report.

Four CLOs totaling $1.9 billion priced last week. While issuance should pick up, it may be constrained by AAA spreads that are currently about 138 basis points more than the London interbank offered rate, 28 basis points wider than the tightest pricing of 2013 seen in May, according to the bank.

JPMorgan widened its U.S. year-end CLO AAA forecast Sept. 6 to between 125 basis points and 130 basis points more than Libor from 100 basis points. Libor is the rate banks say they can borrow in dollars from each other.

The bank’s target for the same CLO portions in Euros is between 140 basis points and 150 basis points, according to the report. A basis point is 0.01 percentage point.

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