By Scott Carpenter
(Bloomberg) — Collateralized loan obligations are seeing a surge in sales volume, spurring strategists to boost their issuance expectations for the year. Strategists at Citigroup Inc. and Barclays Plc have in recent weeks raised their forecasts for new US CLO volume this year, with Barclays lifting its forecast for securities backed by broadly syndicated loans by at least 50%. And analysts at both Morgan Stanley and Nomura have said that CLO equity, the riskiest part of the transactions, now looks compelling, according to research notes from the firms.
The CLO market is benefiting from a rally that’s gripped credit markets broadly as investors grow increasingly hopeful that the Federal Reserve will help the economy avoid recession despite a series of rate hikes that started in 2022. Amid this rally, the CLO arbitrage has improved, signaling more profit can be earned from managing CLOs, Citigroup said in its note.
Although there are still questions about when the Fed will make its first interest-rate cut, the market is taking solace in the fact that rates will probably stay higher for longer. What’s more, despite the highest interest rates in years, default rates for leveraged loans remain below their historical averages, a surprising development that’s helped boost demand for CLOs, said Olivier Gozlan, an investment manager at Crystal Fund, a family of investment vehicles managed by Oristan Ireland DAC. “There’s been a huge shift in the market’s view of CLOs over the last few months,” Gozlan said. “It’s much more bullish.”
Of course, it’s still too early to say how well the leveraged loan market will handle today’s elevated interest rates. Gozlan isn’t overly optimistic about the CLO market’s ability to absorb additional stress in coming months. “It’s difficult for me to be convinced that interest rates for many companies can double and you can have little damage from that,” he said. Elsewhere in credit markets, robust investor demand for bonds has kept risk premiums relatively tight despite ample supply of newly issued debt, while spreads on junk bonds dropped to their narrowest levels since early 2022. A Bank of America strategist said last week that high-grade bonds are experiencing a “goldilocks scenario” of higher yields, lower interest-rate volatility, fund inflows and “hot, but not too hot US data.”
