CLOs Boost Leverage-Loan Market Share to Most Since 2006

Collateralized loan obligations were the biggest buyers of leveraged loans in the first quarter, increasing their market share to the most since 2006, according to the Loan Syndications and Trading Association.

The funds, which buy the loans that are used to back leveraged buyouts, had a 58 percent market share during the first three months of the year, an increase from 53 percent in 2013, the LSTA said in an April 23 report citing Standard & Poor’s Capital IQ Leveraged Commentary and Data. CLOs had a 61.1 percent share in 2006.

Sales of CLOs reached $82 billion in 2013, the third-largest year on record, and have topped $32 billion in 2014, according to Royal Bank of Scotland Group Plc data. Issuance in the U.S. rose to $93 billion at the peak of the market in 2007. Investors have been attracted to the most senior piece of a CLO, the AAA slice, which can offer better returns than similarly-rated debt.

“The relative value offered by CLOs, especially for AAAs, has finally expanded the investor base and you have a lot more buyers,” David Preston, a CLO analyst at Wells Fargo & Co. in Charlotte, North Carolina, said in a telephone interview today.

AAA CLO spreads are about 150 basis points more than the London interbank offered rate, compared with about 85 basis points for AAA commercial mortgage-backed securities, according to Wells Fargo data. Libor is the rate banks say they can borrow in dollars from each other. A basis point is 0.01 percentage point.

Volcker Effect

After the release of the Volcker Rule in December, which doesn’t allow banks to invest in CLOs that own bonds, volume dropped to $2.55 billion in January, the least since $2.2 billion in July 2012, according to RBS data.

CLO volume rebounded in February with $8.9 billion of issuance that month as managers and banks developed funds that were compliant with the rule, according to Wells Fargo data. The San Francisco-based bank increased its 2014 CLO forecast this month to as much as $90 billion, from $60 billion.

Retail loan funds had the second-largest share of the market with 26 percent last quarter, down from 32 percent in 2013, according to the LSTA report.

Investors poured a record $61.3 billion into leveraged-loan mutual funds in 2013, according to Morningstar Inc. data. After 95 weeks of inflows into loan funds, the market had its first outflow in the week ended April 16, according to Bank of America Corp. data. That $320 million outflow was followed by $160 million of withdrawals in the most recent week, the Charlotte-based bank said.

Inflow Volume

CLOs have been able to pick up market share because the volume of inflows has decreased, Preston said.

“The retail share of the market has been going down, even while inflows were still positive, they were smaller over time,” he said.

Inflows have been falling this year, dropping to $2.1 billion in February from $3.7 billion in January, and then decreasing further to $1.9 billion in March, according to Morningstar.

CLOs are a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and return. High-yield, or junk, debt is rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.

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