By RANDY SCHWIMMER, Founder/Publisher, The Lead Left
Everybody talks about yield, but nobody does anything about it. In particular, the Fed’s reluctance to be pinned down to a date certain when rates will rise has leant a “she-loves-me-she-loves-me-not” tone to investors’ worries.
The buy-side toggled all last year between loans and bonds in search of optimal returns. Mutual fund flows have oscillated like metronomes. One week junk funds are cash magnets with investors convinced this low-rate environment will persist as far as the eye can see. Then global slowdown (hence default) worries send that cash scurrying for safe havens.
One would think rate hikes would be honey for floating-rate loan buyers, particularly the better-rated variety. Not so. Indeed, with two exceptions, outflows have occurred every week since last April 14.
High-yield bond funds, in contrast, have had a better run Fixed-income buyers convinced themselves that the Fed’s stance is constructive for the asset class. But new-issue unsecured junk average a 6.3% yield for single-Bs, while similarly rated loans weigh in at…6.3%. So much for relative value.
In contrast to aversion by funds, CLO managers are buying as many loans as they can get their hands on. Mid-October’s bout of volatility helped lift all-in asset spreads, and there’s little sign that will change.
Last November’s regulatory ruling on CLO risk retention, while long-expected, has sent managers and arrangers back to their drawing boards. With a two-year window, the requirement that CLO managers must own at least 5% of the vehicle in equity is bound to result in envelope-pushing structures. Options being discussed include minority investors and financing of the manager equity.
The 2016 deadline has served as an accelerant to launching of new vehicles ($124 billion of volume for last year!). But it has also put a damper on the long-term prospects for any but the most well-capitalized asset managers. CLOs have historically held the lion’s share of leveraged loans, roughly 60%. And while the latest issuance boost has kicked up that participation to almost 68%, the dominance of these trusted vehicles may have peaked.
Elsewhere in loan land, the news was equally tiresome. More regulatory screw tightening came in late October from the Gang of Three. In the Shared National Credit Review (and Leveraged Lending Supplement), the Fed, OCC, and FDIC came down hard on bank purveyors of leveraged loans.
In its best parental warning “Don’t make me come over there” tone, the report cited “serious deficiencies in underwriting standards and risk management” with 31% of leveraged loans having “weak” structures.
Having observed no improvement since 2013’s review, the regulators added helpfully, that “financial institutions should ensure borrowers can repay credits when due.”
On the other hand, encouraging notes were sounded recently at the Wells Fargo Middle Market BDC CEO Forum in Manhattan. Business development companies, while currently small potatoes ($60 billion) relative to CLOs or mutual funds, are enjoying a good run. Close to $30 billion has been raised this year, with a growing pipeline. The transparency and double-digit yield of these mostly public, dividend-paying asset managers seems to be coming at the right time.
Randy Schwimmer is a director on the board of ACG New York. A former member of senior management and investment committees for two leading middle market debt platforms, Randy is founder and publisher of The Lead Left (theleadleft.com), a weekly newsletter about trends and deals in the capital markets. For a copy of his “Secrets to a Successful Job Search, email him at email@example.com.