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Investment vehicles that scoop up risky loans are being launched at a record rate in Europe this year, in response to demand from investors hunting for yields.
More than €22.7bn of so-called collateralised loan obligations have been issued in the first five months of this year, according to Bank of America data, excluding deals that refinance existing CLOs at lower costs.
These vehicles — which snap up dozens of junk loans, repackage them into different rating categories and then sell slices to investors — were shunned in the wake of the 2008 global financial crisis as a result of the havoc wreaked by their close cousins, collateralised debt obligations.
This year’s surge in European issuance highlights how, as in the US, CLOs are now coming back into favour with investors. The data puts the European market, which is a fraction of the size of its US counterpart, on course to beat 2021’s issuance record of €39bn.
“We’re definitely seeing a good amount of new issue supply,” said Aza Teeuwen, a partner and portfolio manager in the asset-backed securities team at TwentyFour Asset Management. He said that managers of these vehicles have been keen to take advantage of the lower yields at which they can issue CLOs.
While managers have been able to issue at lower costs, “from an investor point of view . . . it’s still an asset class that’s incredibly attractive from a yield perspective,” he added.
Asset managers that issue CLOs aim to profit from the difference between the cost of the debt they can raise from investors and the income from the interest on the risky corporate loans that they buy.
The loans bought by CLOs are typically issued by highly-indebted, low grade companies. This debt, which has a floating rate of interest, soared in popularity during the coronavirus pandemic as central banks cut borrowing costs to ultra-low levels. But borrowers were expected to be hit as rates were rapidly raised over the past two years to combat inflation.
However, many borrowers are performing more strongly and have been able to service their debt better than expected, which has attracted investors back to CLOs.
Meanwhile, CLO investors who have been repaid in full by previous vehicles have been keen to recycle their cash back into newly issued products, which has helped support demand.
While the rate of interest compared with government bonds has fallen, “the yields are still very attractive. So for investors looking for carry [income], it is still a very attractive product to buy”, David Nochimowski, head of global CLO and ABS strategy at BNP Paribas told the Global ABS conference in Barcelona last week.
In April Deutsche Bank raised its forecast for CLO issuance in Europe this year by €10bn to €37bn, which would be just shy of 2021’s record. Barclays, Morgan Stanley and BofA have also upped their forecasts as issuance, which was broadly expected to be flat in 2024 on last year, quickly surpassed expectations.
European CLOs now hold €240.5bn in assets under management, while US CLOs now have $1.07tn, according to data from LSEG.
“If you look at issuance levels year to date, we are way, way ahead of 2021. Are we going to annualise that? I think that’s the big question mark,” Alexander Dupont, head of European CLO new issue at Goldman Sachs said at the ABS conference in Barcelona.
“If we’re going to annualise these numbers we do think M&A [mergers and acquisitions] needs to pick up and leveraged buyout activity needs to pick up,” Dupont said.
The high rate of new CLO issuance has come in spite of a scarcity of new underlying loans. Companies have been regularly meeting their loan payments but have not been regularly tapping the market for new capital, leaving buyers including CLOs competing over a dwindling pool of underlying loans.
Supply of European leveraged loans remains low this year at around €31bn for the year to date, according to BofA data. The number represents a slight increase on 2023 but is driven by an uptick in borrowers refinancing their debt, rather than a round of dealmaking or leveraged buyouts.
The resurgence of CLOs in Europe follows a similar trend in the US market, which has also seen rampant issuance. That has prompted Morgan Stanley to raise its US new CLO issue volume forecast to $165bn last month, a $50bn jump from the bank’s year-ahead projection.
Amir Vardi, a portfolio manager and the head of structured credit for Credit Suisse’s Credit Investment Group, told the conference in Barcelona: “We are analysing a record year which will be like $200bn . . . and Europe might also break a record.”
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