Investors outside that club are struggling to get any allocation from primary issuers, they said.
A CLO investor attending the ABS East Conference in Miami said that smaller investors of triple-A rated paper were being left with no opportunities to buy deals.
“A lot of guys don’t syndicate the whole deal,” he said. “So say an issuer pre-places place two thirds [of the triple-A notes] with one buyer. Then it gets really tough for other guys to get into the club after that.”
He added that even some historically big buyers of senior tranches are finding it more difficult to get hold of paper, and an arranger speaking before the conference said that demand at the top of the stack is ‘limitless’. The treasuries of big US banks are said to be crowding out other buyers, even some mainstays like Japanese institutional investors.
Despite recent tightening at the top of the stack, another conference delegate also noted that triple-A paper was “ridiculously cheap” compared with the spreads seen in other asset classes that have rallied since the UK voted to leave the European Union on June 23.
Fundamental changes ahead?
But demand continues to grow from around the globe, and there is real talk of Chinese investors beginning to allocate serious money to CLOs.
“It’s a game changer,” said the investor about Chinese investors coming into the market. He added that the sector could see as much as 40bp of spread tightening at the top of the stack if Chinese interest became more widespread. Given the sheer size of the market, when compared with other Asian investor hubs such as Japan and South Korea, he said that a regular flow of Chinese investors would change CLO market fundamentals.
European investors are also pouring into the US CLO market looking to put money to work. One London-based fund manager telling GlobalCapital before the conference that he was now regularly meeting with US issuers in order to invest in US paper.
But the strength of the dollar still remains a challenge, particularly for investors with sterling denominated liabilities, after the currency’s post-UK referendum free fall.
It is not just in the debt stack where issuers are seeing new investors flooding into the market.
Panellists at ABS East noted that there were some substantial changes in the profile of equity investors looking to jump into US CLOs.
Amit Roy, head of CLO new issuance at Goldman Sachs, told delegates listening to a CLO outlook panel on Monday that the market was seeing new types of equity investors looking to enter the space.
He noted that investors pursuing short-term gains are looking to transition out of CLO equity, while real money is increasingly attracted to the improving arbitrage to equity as spreads tighten.
Roy said that this type of equity capital tended to be from private equity funds or institutions with longer-term liability outlooks, such as insurance companies or pension funds.
Alongside a global search for yield, the performance of CLOs broadly continues to be a driver of the growing investor pool.
Strong performance, growing concerns
A report issued on September 19 by Moody’s found that between 2000 and 2015, CLOs substantially outperformed corporate loans.
The ratings agency found that in that period, Ba rated corporate loans had higher average loss rates than Ba rated CLO notes. Loss rates were 3% for loans and 1.5% for CLOs after five years.
During the same period, corporate loans and CLOs rated single-B showed a disparate performance, according to Moody’s. The average loss rate for loans was 7.6%, compared with 2% for CLOs.
“The historically strong performance of Ba and B rated CLO notes against similarly rated corporate loans reflects their structural protections,” said Moody’s analyst Debjani Dutta Roy.
“It is also attributable to the fact that CLOs are backed by an actively managed portfolio in comparison to individual loans.
“However, speculative-grade rated CLO notes are highly levered and therefore are subject to a high level of performance variability.”
Market participants are increasingly concerned about a possible downturn in the corporate credit cycle, especially in certain sectors like pharmaceuticals.