The U.S. market for collateralized loan obligations, securities that are backed by different types of loans mostly to below investment grade companies, surged in 2013.
The total number of US-based CLO deals in 2013 was up 56 percent over 2012, according to a report by law and fiduciary firm Appleby. The CLO Insider report noted that the 182 CLOs issued in 2013 represented a total value of US$86 billion, surpassing the total issuance for 2012 by US$33.5 billion. The average deal size also increased by 5 percent in 2013 compared to 2012.
The return of this type of securitization is significant for the Cayman Islands, which dominated the market before the financial crisis, as more than 90 percent of the transactions are estimated to be structured using special purpose vehicles registered in Cayman.
Appleby predicts steady activity through 2014
“The CLO market in the second half of 2013 continued to expand as the low interest rate environment has pushed investors into securities that offer the possibility of higher returns,” said Julian Black, the Cayman-based partner and global head of Structured Finance at Appleby. “Looking forward, we expect credit quality to remain strong in 2014 and that the U.S. CLO market will remain similar to 2013.”
In the second half of 2013 deal activity slowed from 96 to 86 transaction with the average deal size of US$464 million 3 percent lower than in the first six months of the year.
“In total, there was US$39.9 billion of issuance in the second six months of 2013,” said George Bashforth, head of Directorship Services, Appleby Trust (Cayman) Ltd.). “When added to the issuance for the first half of the year, the total puts 2013 64 percent ahead of the total issuance in 2012.”
In the wake of the financial crisis, CLO issuance had dropped significantly from nearly $100 billion in 2007. In particular, more complex structured credit transactions were blamed for exacerbating the credit crisis. However, as The Economist argues in its current edition, not only CLOs but securitization in general is making a comeback. Policymakers and regulators want to rehabilitate parts of the market for its ability to generate more lending activity, which, it is hoped, will kick-start ailing economies.
Banks that are subject to higher capital requirements designed by regulators to make them safer are looking to CLOs and other securitization instruments to move assets off their balance sheets. The resulting improved capital ratios will allow the banks to issue more loans.
Current CLO deals are different
Current CLO deals are different from the pre-crisis days. New CLO transactions feature higher levels of subordination, tighter collateral eligibility requirements, and shorter non-call and reinvestment periods, Appleby said.
The firm’s report forecasts the total deal value for 2014 to range from US$60 billion to US$80 billion, but notes that new risk retention rules, which may take effect in the first quarter of the year, could impact the market.
“In essence, we expect the pace of issuance in 2014 will hold up, subject to constraints caused by the scarcity of AAA investors and the effect of risk retention rules,” Mr Black said.
Fitch Ratings said in October the risk retention rules enacted in Europe and proposed in the U.S. could increase balance sheet leverage for those asset managers who need to obtain financing to comply with the rules.
Managers without the financial resources or market access to comply, in turn might have to exit the CLO market, or seek an acquisition by a larger manager. This could drive further industry consolidation as managers are looking for greater scale and diversification, Fitch Ratings said.
The European Banking Authority’s Capital Requirements Directive states that, effective Jan. 1, 2014, CLO originators or sponsors will be required to retain a 5 percent interest in originated or sponsored CLOs. The Dodd-Frank Act proposes a similar framework in the U.S., although it is not expected to be finalized until fourth-quarter 2015 at the earliest.
Risk retention rules have already had an impact on CLO deals in Europe, which is a much smaller market than the U.S.
In the second half of 2013 Appleby saw a total of 16 transactions with an aggregate value of €6.2 billion (US$8.5 billion).