The slumbering CLO awakes?

Posted by Tracy Alloway on Dec 17 12:01.

Earlier this month, FT Alphaville asked whether synthetic CLOs were gone for good, or merely hibernating?

This week it looks like the synthetic CLOs’ simpler cousin, your run-of-the-mill business loan-packed CLO, is beginning to awaken:

Dec. 16 (Bloomberg) — Banks may arrange as many as 100 collateralized debt obligations backed by high-yield, high-risk loans in 2010 following Wells Fargo & Co.’s “landmark” offering yesterday, according to Guggenheim Partners LLC.

Guggenheim was the main investor in the securities of Newstar Commercial Loan Trust 2009-1, a $250 million CLO arranged by Wells Fargo, said Scott Minerd, who helps supervise more than $100 billion as Guggenheim’s chief investment officer.

Wells Fargo is joined by JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc. in approaching managers of leveraged loans to offer terms for new CLOs following a record rally this year in the debt. The $440 billion market for CLOs, which pool loans and slice them into securities of varying risk, largely disappeared at the end of 2007 as losses on subprime mortgages led investors to flee bundled debt.

. . . Leveraged loans have returned a record 49.8 percent this year after losing an unprecedented 28.2 percent in 2008 following the failure of Lehman Brothers Holdings Inc., according to the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index. Leveraged loans are rated below BBB- by S&P and less than Baa3 at Moody’s Investors Service.

Ironically the stated reasoning behind this latest CLO is almost the polar opposite to the thing that fueled the early 2008 (mini) CLO boom-of-desperation.

This for instance, is from a February 2008 Wall Street Journal article:

In the past few days, low-rated corporate loans — the kind that fueled the buyout boom of recent years — have plummeted in value. As a result, banks are expected to try to unload some of those loans this week at fire-sale prices.

`Unloading’ eventually became synonymous with `creating CLOs’ — which helps banks shift high-risk loans off their balance sheets.

And the plummeting value of leveraged loans in 2008 saw a plethora of `landmark’ deals like Carlyle’s CLO funds, and err, Lehman’s Freedom CLO, which was packed with stuff like bank credit lines to CountryWide Financial — the mortgage house hit hard by the crisis and taken over by Bank of America.

The issue in 2008 was that the dropping value of leveraged loans essentially created margin calls — forcing sales of the CLOs’ assets in the event that counterparties couldn’t make the payments– which in turn led to further reductions in loan values. A sort of vicious CLO-circle, if you will.

Lots has of course changed since 2008 — but then again, lots hasn’t.

For instance, the pricing difference between the primary and secondary market for loans is still pretty wide, which makes some people doubt an imminent CLO comeback.

From Structured Finance News:

However, some still doubted the likelihood of an imminent comeback for the market. Several CLO market participants noted that the arbitrage between the senior financing and the yield on other assets, mainly those that are trading on the secondary, will continue to make it difficult for any new CLOs to launch. “You need two pieces — attractive equity rates and reasonable financings — to create that arbitrage,” a New York-based CLO manager told Leveraged Finance News.

For those interested, The AAA-rated tranche of the Newstar CLO will pay 375bps over Libor, for instance, while the AA-rated is priced at 750bps. The BB-rated bit and the unrated remainder reportedly weren’t offered to Guggenheim.

Related links:
Guggenheim Partners buys most of a new $275m CLO – WSJ
Leveraged loans are the new bonds – FT
Ratings agencies draw fire from CLOs – FT