CLO Market Poised to Freeze, Raising Risk to US Leveraged Loans
The biggest buyers of leveraged loans are getting pushed to the sidelines, which is set to make it harder for riskier companies to tap the $1.4 trillion market for such debt.
Money managers are poised to dramatically slow new issuance of collateralized loan obligations, which buy and pool buyout debt, in the coming weeks, according to Goldman Sachs Group Inc. and Morgan Stanley analysts. That’s because a large selloff of such securities has enticed investors to buy what’s already out there and pressured CLO issuers to ramp up pricing.
Wall Street banks have been trying to sell leveraged loans they committed to before volatility hit markets. But investors are reducing their exposure to risky corporate debt in light of tariffs, with US leveraged loan funds recently recording their biggest-ever weekly outflow of $6.5 billion. Without new CLOs, banks will find it even more difficult to offload the buyout debt.
There are ample securities available to buy in the secondary market, particularly as exchange-traded funds that focus on CLOs have been selling off bonds in their portfolios this month to meet redemptions.
“We think most investors looking to add risk should focus on the secondary market,” Goldman strategists wrote in an April 10 note. Secondary deals can often be both cheaper and offer greater yields than new issuances.
Investors are starting to demand pricing on new deals rise to meet secondary sales. Spreads on the highest-rated tranche of CLO bonds, which account for about 60% of a transaction, have already widened as much as 4 percentage points over the benchmark rate in the past few weeks, according to a Barclays Plc report. As spreads widen, it becomes more expensive for managers to put together deals, making it harder for them to profitably invest in loans.
ETFs absorbed just over half of the net new investment-grade bonds issued from 2024 to the end of February, according to Beach Point Capital Management estimates. But since then, they’ve seen significant outflows.
The Janus Henderson AAA CLO ETF saw nearly $600 million of withdrawals on April 7, the biggest single-day outflow since the 2020 inception of the fund, which manages about $20 billion of assets, according to data compiled by Bloomberg. The outflows have forced some CLO ETFs to liquidate some of their holdings to help meet redemptions.
In total, CLO ETFs recorded $1.6 billion of outflows in just the first three days of last week, according to Barclays.
Tariff-led volatility has also hit European CLO issuance, with Ares pulling a deal last week citing adverse market conditions. But while activity has slowed, it hasn’t come to a standstill. Trinitas Capital Management succeeded in pricing a transaction last Monday, even as CLO managers grappled with the implications of a fresh set of guidelines from European regulators.
With that exodus, money managers and hedge funds are swooping in to buy the CLO debt at a discount. Auctions for CLO securities, known as bids wanted in competition, jumped to $3.53 billion last week, the highest volume in a single week since at least 2019, according to data from Bank of America Corp.
Bid lists for portfolios of CLO bonds were sent out every day last week, according to market participants, often times coming from large ETFs looking to sell at the end of the day.
“CLO AAAs are the part of the capital structure that have sold off the most on a relative basis,” said Kashyap Arora, the co-chief investment officer at Vibrant Capital Partners. “It’s the first significant selloff in the CLO market where ETFs are a meaningful portion of the market.”
Wider pricing on secondary CLO sales has pushed investors to demand more premium on new-issue debt. Some are asking for as much as 160 basis points on AAA tranches, according to people with knowledge of the matter, a stretch from the around 130 basis points that CLOs were pricing at last week.
“Historically, AAA CLOs have been rock-solid credits, but it takes time to create new ones,” said Jim Stehli of Polen Capital Management. “When you’re in these weird pockets of high volatility where spreads are moving rapidly, it’s hard for buyers and sellers to agree on levels.”
Some managers are already agreeing to wider pricing. Hedge fund Arini, run by Credit Suisse Group AG’s former star trader Hamza Lemssouguer, priced its first US CLO last week, with AAA bonds at 150 basis points over the benchmark rate, according to data compiled by Bloomberg.
Some CLO managers are trying to take advantage of a drop in leveraged loan prices. Prices on the debt slipped last week to under 95 cents on the dollar, according to a Morningstar LSTA index.
Elmwood Asset Management is working with Japanese bank Sumitomo Mitsui Financial Group Inc. on a quasi- “print-and-sprint” transaction, in which CLO managers quickly purchase leveraged loans in the secondary market rather than slowly buying up the debt in the primary market. Golub Capital is pursuing a similar transaction for a CLO with a fixed portfolio of loans.
But those deals are hard to pull off when loan prices keep moving and CLO bond prices are not locked in, market participants said.
“Despite the selloff, CLOs haven’t moved as much as in other periods of volatility, especially some of the lower tranches, and especially relative to other risk assets,” said Arora at Vibrant Capital Partners.
With assistance from Bruce Douglas.
This article was generated from an automated news agency feed without modifications to text.
