There has been a lot of focus lately on who might end up holding the bag if the near $1.3 trillion U.S. leverage loan market goes belly up.
Collateralized loan obligations (CLOs), which own nearly half of all U.S. leverage loans, would seem an obvious pain point if the economy sours and makes it harder for companies to keep up on their debts, but a new Bank of America Merrill Lynch report shows that a significant portion of all U.S. CLOs have attracted investors with relatively stable sources of capital, making them likely less vulnerable to redemptions and fire-sales.
Using public data, including a Federal Reserve report from July about CLO holders, Bank of America analysts found that most CLO debt appears to reside with a sturdy buyer base that likely can withstand some volatility without needing to shed holdings in a panic.
“The data we obtain from these sources, together with the anecdotal color we get that leverage still doesn’t seem to be widely used in the space, leads us to believe that the majority of U.S. CLOs are indeed in the hands of longer-term and real-money investors,” wrote BAML analysts led by Chris Flanagan in a recent client note.
This chart shows that insurance companies were the No. 1 holders of U.S. CLO debt over the past five years. The tally included only U.S. CLOs domiciled in the Cayman Islands, which for tax purposes, includes most of the sector.
Bank of America Merrill Lynch
Depository institutions, like banks, and mutual funds tied for the No 2 and No 3 spots with a near 18% share each, followed by pension funds at about 11%.
Leveraged loans are extended to corporate borrowers with already sizeable debt loads or poor credit histories. CLO funds borrow in the bond market to purchase pools of leverage loans, which are then managed by the fund for a fee.
Bondholders of CLOs are entitled to proceeds when corporate borrowers make their loan payments, but also run the risk of being wiped out if enough loans in a pool default.
Lately, lower-rated classes of CLOs, which broker-dealers, hedge funds and others often buy for the promise of higher returns, have suffered from spotty liquidity, which can exacerbate price swings in a markets sell-off.
Single B-rated CLOs were fetching equity-like yields of 13.1% last week, ranking them among the highest-yielding assets this year in structured products, according to BAML data.
The Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +2.21% was up 15.12% on Tuesday on the year to date, while the S&P 500 /zigman2/quotes/210599714/realtime SPX +1.48% added 18.4% and the Nasdaq Composite Index /zigman2/quotes/210598365/realtime COMP +0.77% gained 21.4%.
In May, the U.S. House Financial Services Committee held a high-profile hearing on the leverage loan industry to study if it could pose systemic risks to the financial system. One take away from expert witnesses was regulators lack a full picture of where the risks sit.