Barclays Sees 2016 CLO Issuance Dropping as Rate Hike Loomsby
Bank forecasts $70 billion to $80 billion of CLOs in U.S.
Managers face headwinds from risk-retention regulation
Wall Street banks are predicting that collateralized loan obligations, the biggest buyers of leveraged loans, will lose even more steam, as the market declines for a second year.
Barclays Plc is forecasting $70 billion to $80 billion of new CLOs as the market adjusts to looming regulation and rate increases by the Federal Reserve, down from a projection of as much as $110 billion for this year, according to a report on Friday. The forecast follows a JPMorgan Chase & Co. estimate on Thursday that issuance next year will drop to as low as $60 billion in the U.S.
CLOs pooled a record $124 billion last year, according to Wells Fargo & Co.
Managers are facing headwinds from new risk-retention rules, which go into effect in December 2016 and require them to hold 5 percent of their deals. A plan to meet the requirements has been "an increasing focus for CLO investors and managers" as only a minority this year comply, Barclays credit strategists said in the report.
The Fed raising interest rates for the first time since 2006 may also suppress demand for CLOs because it would have the effect of diminishing returns for investors in the riskiest portion of the funds, according to Barclays. CLO creation has already dropped off in the second half of this year as concern about the collapse in oil prices that began in mid-2014 keeps rippling through markets.
A report released Thursday by the Federal Reserve, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency found flaws in financing in oil-and-gas exploration and production. The regulatory review, which covered 2014, also found that leveraged lending by U.S. banks remains too risky despite some improvement.
CLOs are still on pace to raise more than $95 billion this year even with the slowdown since June, according to Barclays. That falls within the bank’s 2015 forecast of $90 billion to $110 billion.
Some firms aren’t waiting until next year to show investors they’re able to comply with the risk-retention rules, as putting up the necessary capital may prove too expensive for some managers to stay in business.
Investors are asking, "OK, have you thought this through?" said Bradley Rogoff, a New York-based credit strategist at Barclays.
Marathon Asset Management has raised $200 million for a fund that will help it fulfill the regulatory requirement, according to a person with knowledge of the matter. The investment manager, which oversees about $12.5 billion, plans to tap its new fund to own about half of the so-called equity tranche of its CLOs, the person said.
The new regulation forces managers of CLOs, which bundle leveraged loans and slice them into securities of varying risk and return, to have some skin in the game. The equity portion is the riskiest.
Large insurance companies, hedge funds and private-equity firms may have an easier time complying because of their own deep pockets, Rogoff said.
Conning, an insurance asset management firm with $93 billion of assets, said Thursday that it’s buying CLO manager Octagon Credit Investors. New York-based Octagon, which invests in leveraged loans and high-yield bonds, has about $12.8 billion under management.
"We expect risk retention to be a minor headwind for issuance as market consolidation continues," the Barclays strategists wrote in Friday’s report.