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June 28 (Reuters) - Banks are increasing their US Collateralized Loan Obligation (CLO) forecasts with issuance set to surpass some of the most pessimistic 2017 predictions.
The market has defied expectations with issuance this year of US$49bn through June 23, 90% higher than the same period last year, according to Thomson Reuters LPC Collateral. If these revised forecasts are realized, 2017 would be among the top five years of volume ever. Issuance in 2014 of US$123.6bn is the record.
This year’s forecasts initially ranged from US$50bn to US$70bn with banks citing a lack of collateral and rules that require managers to be on the hook for a portion of their fund’s risk as reasons for the expected dip from US$72.4bn in 2016.
“Issuance so far this year has been a bit stronger than expected,” said Rishad Ahluwalia, head of CLO research at JP Morgan.
The bank, which started the year with one of the most pessimistic 2017 forecasts, restated its prediction to US$85bn to US$95 of volume this year from its original projection of US$50bn to US$60bn, according to a June 16 report.
Morgan Stanley raised its forecast to US$80bn in issuance, up from its original prediction of US$70bn, according to a June 16 report, while Wells Fargo raised its forecast to US$85bn from US$70bn in a June 22 report. Deutsche Bank increased its projection to US$95bn from US$65bn, according to a June 28 report.
These forecasts do not include CLO refinancings or resets.
A Wells Fargo spokesperson, a Morgan Stanley spokesperson and a Deutsche Bank spokesperson all declined to comment.
Low loan volume and debt repricings are potential limiting factors to continued robust CLO issuance this year.
New institutional loan volume of US$53.72bn in the first quarter was down more than 10% from the prior quarter, according to Thomson Reuters LPC data. The lack of new deals and increased investor interest for floating-rate debt allowed borrowers to refinance a record US$195.8bn of loans in the first three months of the year.
The lower interest payments can eat into the most junior CLO investors’ returns because they are paid last with whatever interest is left over after a deal’s debtholders are paid. As borrowers cut costs, equity holder distributions decrease.
“The main risk continues to be spread compression on the underlying loans, making arbitrage to the equity more challenging,” said Ahluwalia. “Another factor is the lack of collateral given the strong loan repricing and refinancing activity. So we’ll see how the next six months play out.”
Risk retention, part of Dodd-Frank that requires managers to hold 5% of their fund, was often cited in initial forecasts as an impediment to issuance, but managers have developed options to comply.
Managers may buy the retention directly or with financing from a third party. Many have set up a capitalized manager vehicle (CMV) – a standalone management company that oversees the CLO to buy the retention stake – or a majority-owned affiliate (MOA) or capitalized majority-owned affiliate (C-MOA) to purchase the required amount.
“The fundraising for CMVs and MOAs has gone quite well,” said Dave Stehnacs, a portfolio manager at ZAIS Group. “It is an opportunity to invest in CLOs as well as participate in the revenues of the asset management companies.” (Reporting by Kristen Haunss; Editing by Leela Parker Deo and Chris Mangham)