CLO issuance in the U.S. in 2018 has topped $125 billion, officially eclipsing the all-time record of $124.1 billion set in 2014, according to LCD.
The recent activity raises the total size of the outstanding collateralized loan obligation market in the U.S. to $600 billion, according to J.P. Morgan, which projects the market to grow to $700 billion by the end of 2019, after expected net issuance of $100 billion next year, taking into account maturing CLOs and loans that are paid down.
To be sure, the CLO market has accelerated in recent years, and following the financial crisis. The total outstanding at the end of 2014 was $350 billion. The pre-crisis peak was $256 billion in September 2008.
CLOs are a crucial component of the leveraged loan investor base, accounting for about 60% of U.S. leveraged loans, according to LCD. The record comes at an interesting time for the market, as an aging credit cycle shows signs of stress, including an expected slowdown in rate hikes and pronounced equity gyrations.
New highs in M&A
This expansion in the CLO market is largely attributable to two forces: the rapid growth of the underlying leveraged loan market, which has ballooned to over $1 trillion today from $554 billion at the end of 2007, and the global hunt for yield, especially of late, as investors have sought floating-rate assets in response to the Federal Reserve’s interest rate hikes.
In that loan growth, there is M&A. Loans issued in 2018 due to M&A have reached a record $273.2 billion, according to LCD. This exceeds the previous high of $250.8 billion set in 2007, and the $239 billion in 2017. In total, $435.8 billion in institutional loans have been issued so far this year.
Global hunt for yield
Historically low interest rates set by central banks across the world have driven a number of investors — especially foreign banks — into the U.S. CLO market where yields, especially when factoring in a rising London interbank offered rate, have been higher, compared to similarly rated other types of assets.
Japan’s agricultural cooperative bank Norinchukin, for example, which manages a large, $840 billion investment portfolio, recently revealed that it has grown its CLO holdings by about 50%, to about $51 billion globally, adding another $17 billion in CLOs over the first half of this year.
This comes as hedging costs have become increasingly expensive for Japanese investors buying U.S.-dollar-denominated assets, sending real yields on fixed-rate AAA holdings, such as the 10-year U.S. Treasury, negative starting in September.
Many U.S. banks are also active buyers of CLO paper. Data collected by the different regulatory bodies at the Federal Reserve Board of Governors shows that the largest U.S. banks collectively own some $90 billion in CLOs.
After financing costs on CLO AAA tranches, which make up about 60% of the total funding costs of a CLO, reached highs of 161 basis points in the second quarter of 2016 during the energy selloff, they fell rapidly, to under 100 bps in the first quarter of this year.
And as the CLO market has grown, funding costs have lessened for issuers in the leveraged loan market. Over that time frame, the average spread on a single-B institutional term debt had reached a low of L+342 in the first quarter, from L+496 in the first quarter of 2016.
Note: This article has been updated to correct the expected 2019 net CLO issuance figure ($100 billion).