US CLO Sales Reach Almost $185 Billion, Breaking Record

(Bloomberg) — About $184.7 billion of bonds backed by foreclosure loans have been issued this year, setting an annual issuance record for the third time since 2018.

Sales of collateralized loan obligations, which combine leveraged loans into bonds, topped the record $183.8 billion set in 2021, data compiled by Bloomberg News show. Prior to this, the level that needed to be surpassed in 2018 was $130.4 billion.

Yield-hungry insurers, banks and exchange-traded funds have driven demand this year, while a wave of redemptions has limited net supply. This resulted in a tightening of risk premiums on CLO debt, which significantly reduced the cost of originating CLOs and helped accelerate bond issuance.

“All the skeptics who follow the CLO space have been misled this year,” said John Kershner, head of U.S. securitized products at Janus Henderson Group Plc. CLOs “continue to tighten policy, continue to have strong liquidity and, perhaps most importantly, continue to have strong demand given that the trajectory of future Fed rate cuts becomes increasingly shallow.”

CLOs are funded at tighter spreads, making it cheaper for CLO managers to buy the underlying leveraged loans. Tighter spreads have been the “main driver” of issuance this year, a trend likely to continue next year, according to Deutsche Bank AG.

By the end of October, risk premiums on broadly syndicated AAA CLO debt had fallen to about 130 basis points over the overnight secured funding rate, down from 190 basis points at the start of 2024, ratings agency Kroll Bond showed in a Nov. 18 report.

High CLO redemptions have largely led to tightening spreads, according to Deutsche Bank, which expects redemptions to reach $140 billion to $150 billion this year.

“This year’s issuance was driven by AAA payout volume, which the market underestimated early in the year,” said Dan Ko, senior director and portfolio manager at Eagle Point Credit Management. “AAA’s net supply has been negative this year and investors have been unable to replace paper due to resets, refinancings and liquidations, and as a result spreads have continued to narrow.”

In May, Morgan Stanley strategists recorded negative net bond issuance for the first time since the financial crisis. “Today, record new issuance brought the CLO market back to $15 billion in net issuance for the year,” Gavin Zhu, Gabriel Reyes Esclasans and James Egan wrote on November 20.

This year’s issuance volumes include a wide range of CLOs, including those backed by ratings sources as well as infrastructure debt, according to data compiled by Bloomberg.

A wave of CLO refinancings helped make October the busiest month ever in terms of gross offerings, recording more than $55 billion in CLO debt issuance, according to JPMorgan Chase & Co.

Disinflationary sentiment in the U.S. and a strong labor market also contributed to the volume increase, Deutsche Bank’s Conor O’Toole and Jamie Flannick wrote in their Nov. 19 securitization outlook.

Ultimately, according to Kershner, there are three main factors driving new bond issuance.

“First of all, is there demand? Secondly, does arbitrage work? And third, are there enough leveraged loans to build the warehouse and seal the deal?” – he said. “We believe the answer to all three questions is “Yes.”

However, the new emission record may not last long. Morgan Stanley expects $200 billion in new CLOs next year, while Deutsche Bank and Nomura Securities Inc. expects $205 billion, driven by increased leveraged buyout and M&A activity. For the first time in CLO’s “relatively short” history, the $200 billion mark will be reached, according to Deutsche Bank.

Bank of America Corp. forecast it’s even higher at $215 billion for 2025. It’s also supported by expectations of credit expansion from a surge in mergers and acquisitions and leveraged buyouts, strategists led by Pratik Gupta and Chris Flanagan wrote Nov. 19.

“Risk sentiment, strong reinvestment demand and ETF inflows should lead to further tightening of AAA spreads, leading to higher issuance,” Nomura analysts Paul Nicodem, Olive Bean and Joseph Geis wrote in a Nov. 7 note.

Kroll’s full-year forecast is on the lower end of estimates at $170 billion. Macroeconomic uncertainty driven by inflation and geopolitics, as well as tight CLO spreads and tight arbitrage, could be headwinds for the asset class, while tailwinds could include lower funding costs, weakening liquidity and continued growth in private lending, write Sean Malone and Gabriele Gramazio from Kroll. .

Analysts at JPMorgan Chase & Co. forecast $150 billion in new supplies by 2025. They expect a slight increase in market size as legacy CLO deals pay off, according to an Oct. 16 research report.

“Assuming this market remains risk-on and the Fed is only one to three cuts away (which is what the market is expecting), I think demand will continue and issuance will continue at a rapid pace to meet it.” – Kershner said.

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