If there is one trend that emerged quite strongly in 2013, it was the rise of the leveraged loan – otherwise known as debt extended to borrowers who are already considered risky or leveraged with excessive debt in some way.
The benefit to investors is loans of this nature tend to come with higher interest rates to price in the considerable risk.
James Frischling, president of NewOak, reported Monday that investors in 2013 gravitated toward higher risk products with interest rates remaining near zero, making returns harder to come by.
In addition, the return of the collateralized loan obligation spurred along "record issuance of leveraged loans,” Frischling pointed out. He says investment managers pushed more than $75 billion CLOs this year – the largest issuance amount since 2007.
“The CLO market has historically become a little ‘frothy’ when the demand from these managers for leveraged loans exceeds 30%," the NewOak president said. “When CLO-bid the for leveraged loans exceeds 60%, history suggests loan quality suffers. In 2013, the bid for leverage loans from CLO managers exceeded 50%.”
Even though heightened risk or market frothiness remain big concerns, Frischling says the Volker rule and demand from AAA investors are now keeping CLOs in check.
“With a limited number of investors in this tranche, spreads will remain wide and create obstacles for many CLO managers to enter the market without dedicated equity sponsorship,” he added. “In turn, the Volker rule is curtailing some issuance as market participants address the uncertainties surrounding its implementation and impact.”
So what does he see in 2014? Expect CLOs to continue in their pursuit of leveraged loans.
"More AAA buyers will emerge, given the high coupon for the associated risk, and the Volker rule will result in the creation CLO 3.0, which will only drive CLO issuance higher," he wrote.
