(Bloomberg) — About $184.7 billion of bonds backed by buyout loans have been issued this year, setting an annual issuance record for the third time since 2018.
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Sales of collateralized loan obligations, which package leveraged loans into bonds, have climbed past the $183.8 billion record set in 2021, data compiled by Bloomberg News shows. Before that, the level to beat was $130.4 billion, in 2018.
Yield-hungry insurers, banks and exchange-traded funds fueled demand this year while a wave of redemptions crimped net supply. That tightened risk premiums on CLO debt, essentially cutting the cost of putting CLOs together and helping to turbocharge issuance.
“All the naysayers that follow the CLO space have been misguided this year,” said John Kerschner, head of US securitized products at Janus Henderson Group Plc. CLOs “continue to tighten in, continue to have great liquidity and probably most importantly, continue to have high demand given the trajectory of future Fed rate cuts is becoming more shallow.”
CLOs are funding at tighter spreads, which makes it cheaper for CLO managers to buy the underlying leveraged loans. Tighter spreads have been a “core driver” of issuance this year, and the trend is likely to continue next year, according to Deutsche Bank AG.
By the end of October, risk premiums for broadly syndicated AAA CLO debt narrowed to about 130 basis points over the Secured Overnight Financing Rate, from 190 basis points at the start of 2024, a Nov. 18 report from Kroll Bond Rating Agency shows.
A high level of CLO bond redemptions mainly drove spreads tighter, according to Deutsche Bank, which anticipates redemptions reaching $140 billion to $150 billion this year.
“This year’s issuance has been driven by the volume of AAA paydowns, which the market underestimated at the beginning of the year,” said Dan Ko, a senior principal and portfolio manager at Eagle Point Credit Management. “AAAs have seen negative net supply this year, and investors have not been able to replace the paper because of resets, refis and liquidations and as a result, spreads have continued to tighten.”
Issuance Rebound
In May, Morgan Stanley strategists observed negative net issuance for the first time since the financial crisis. “Today, record new issuance has brought the CLO market back up to +$15bn of net issuance on the year,” Gavin Zhu, Gabriel Reyes Esclasans and James Egan wrote on Nov. 20.
This year’s issuance tally includes a wide range of CLOs, including those backed by rated feeders as well as infrastructure debt, data compiled by Bloomberg shows.
A wave of CLO resets or refinancings helped make October the busiest month of all time for gross supply, according to JPMorgan Chase & Co., which recorded more than $55 billion of CLO debt issuance.
The disinflationary mood in the US and a resilient labor market have also helped push up volume, Deutsche Bank’s Conor O’Toole and Jamie Flannick wrote in their Nov. 19 securitization outlook.
Ultimately, there are three main drivers of new issuance, according to Kerschner.
“One, is demand there? Two, does the arbitrage work? And three, is there enough leveraged loan supply to build up a warehouse and print a deal?” he said. “We believe the answer to all three of these is, ‘Yes’.”
Looking Ahead
The new issuance record may not last long, though. Morgan Stanley anticipates $200 billion of new CLOs next year while Deutsche Bank and Nomura Securities Inc. both expect as much as $205 billion, bolstered by a ramp up in leveraged buyout activity and mergers and acquisitions. It would be the first time in the “relatively short” history of CLOs that the $200 billion mark is scratched, according to Deutsche Bank.
Bank of America Corp.’s 2025 forecast is even higher at $215 billion and also supported by expectations for more loans as a result of an uptick in M&A and leveraged buyouts, strategists led by Pratik Gupta and Chris Flanagan wrote on Nov. 19.
“Risk-on sentiment, robust reinvestment demand, and ETF inflows should drive AAA spreads to continue to tighten, resulting in higher issuance,” Nomura analysts Paul Nikodem, Olive Bian and Joseph Gais wrote in their Nov. 7 note.
Kroll’s annual projection is at the lower end of estimates at $170 billion. Macroeconomic uncertainty stemming from inflation and geopolitics, as well as range-bound CLO spreads and compressed arbitrage could be headwinds for the asset class, while tailwinds could be lower financing costs, easing liquidity and continued private credit growth, Kroll’s Sean Malone and Gabriele Gramazio wrote.
Over at JPMorgan Chase & Co., analysts are calling for $150 billion of new supply for 2025. They expect negligible growth in market size as older CLO deals pay down, according to an Oct. 16 research report.
“Assuming it continues to be a risk-forward market and the Fed only has one to three more cuts to go — which is what the market is expecting — I think demand continues and issuance will continue apace to meet it,” said Kerschner.
