Investors are clamoring for CLOs because they carry ratings as high as AAA and typically pay more than government bonds or other alternatives that have yielded next to nothing amid an unprecedented era of low rates. CLOs also pay floating rates, offering protection against resurgent inflation.
While the bonds are linked to loans to companies that are often rated junk, they’re structured to offer a cushion against defaults, an attractive feature amid an uneven economic recovery.
That demand is flowing through to the so-called leveraged loan market, as the money managers that assemble CLOs scramble to get their hands on debt sold by junk-rated companies. That’s making it easier for speculative-grade corporations to borrow, and for private equity firms to pull off leveraged buyouts.
Lawyers that write prospectuses and other documentation for CLOs say they’re working all hours and even pulling all nighters to keep up with the business. J. Paul Forrester, a partner at Mayer Brown in Chicago, said his CLO group has pulled in some colleagues from teams that cover areas like commercial mortgage bonds, but there are enough nuances to CLOs that you can only repurpose a few people from other areas.
“We worry that people are burning out. It’s gotten to the point that we are afraid that people will run out of the building screaming,” Forrester said. “There’s only so many hours in the day.”
With so much deal flow, buyside firms have been hiring more bankers than usual. Theo Fleishman went from CLO arranger Natixis SA to buyside firm Nearwater. Oswald Espinoza moved from JPMorgan Chase & Co. to KKR & Co. Cyrus Moshiri switched from Goldman Sachs Group Inc. to New Mountain Capital.
“There has been an unnatural amount of turnover at the CLO desks on the sellside,” said Don Young, co-founder of CBAM, an asset manager that builds and sells CLOs. “People are being bid away by both the buyside as well as other banks.”
Over the next few months, most pandemic-era deals will end what’s known as their “non-call period,” when refinancing and resets are restricted. Because many were sold when risk premiums were unusually high, market watchers expect a large number of them to be refinanced or reset. About 80% of these Covid-era deals ending their non-call period were rated by S&P only, or S&P and Fitch, according to Nomura.
And before the pandemic, most transactions had two year non-call periods, so deals minted in 2019 can be refinanced or reset as well, meaning there could be more deals that can be reworked than usual.
Nomura estimates about $140 billion of deals were in the money for a refi or reset in May, and for that amount to increase to $180 billion by year-end as more deals roll off their non-call period. In mid-January, just $111 billion of securities were eligible for refinancing or resetting.
On top that, new CLO creation is going strong. Investors in search of higher yielding assets are eager to buy the equity portions of the deals, which offer the highest potential payments and are the first to take losses when companies default. Once those portions of deals are placed, it’s often relatively easy for bankers to offload the less risky parts.
All this is unlikely to stop anytime soon, according to Rob Zable, senior portfolio manager of U.S. CLOs and closed-end funds at Blackstone Credit.
“The fundamental picture continues to rapidly improve, which we anticipate will accelerate further in the second quarter,” Zable said. “Refi, reset and new issue volumes have been elevated and we expect this to continue given strong performance and investor interest.”
—With assistance from Sarah Husband.
This article was provided by Bloomberg News.