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CLOs, Leveraged Loans Will Miss Most of New Fed Plan Bounty (1)

April 10, 2020, 12:57 PM

There’s a huge catch to the Federal Reserve’s purchasing program that has been widened to include collateralized loan obligations: The central bank will only buy AAA bonds of CLOs that hold newly-originated leveraged loans.

The expanded Term Asset-Backed Securities Loan Facility (TALF) announced by the Fed Thursday was welcomed by the $690 billion CLO market with Wells Fargo analysts led by Dave Preston hailing it an “early Easter present.” Yet there’s already skepticism, including from Preston, about how quickly it can help kick-start the new issue machine that has sputtered amid volatility caused by the coronavirus with only a couple of deals surfacing in the past few weeks.

Driving those doubts is the moribund leveraged loan market which has only seen two deals come to market in the past month.

“The restrictions severely limit the applicability,” said Joseph Beach, partner at law firm Cadwalader Wickersham & Taft, LLP. “The new TALF rules will not quickly help CLOs because there isn’t a ready supply of newly issued leveraged loans.”

The only borrowers to attempt new loan sales of late are a pair of casino operators looking for cash to shore up liquidity while their businesses remain shuttered because of the pandemic.

Texas billionaire Tilman Fertitta borrowed $300 million to keep his restaurant and casino empire afloat through year-end, paying a hefty all-in yield of at least 14%. Everi Holdings Inc., which makes slot machines and other games, is also offering an all-in yield of at least 14% for a $125 million loan which may price next week.

Read more: Fertitta wins $1.4 billion orders for loan to save casino empire

But those deals are hardly sufficient to help crank up CLO issuance which needs a steady supply of new debt to repackage into securities if the secondary market isn’t an option. Moreover, CLO managers need to buy loans from a wide range of borrowers to satisfy diversity requirements.

“Banks will not be able to originate leveraged loans with the thought that TALF will help them, unlike with credit cards, autos, and student loans,” said Beach.

Barclays Plc strategists led by Bradley Rogoff said in a note Thursday that the newly-issued loan restrictions may make CLOs’ addition to TALF “almost meaningless.” They said some banks could look to make balance sheet CLOs by funding existing bridge commitments, but the universe of those deals is relatively small and securitizing that debt may not make sense for many lenders.

Junk-bonds stand to gain more from the Fed action than loans, Citigroup Inc. strategists led by Michael Anderson said. The program is nonetheless boosting sentiment in the $1.2 trillion leveraged loan market. Secondary prices strengthened on the back of the Fed move, according to people familiar with the matter. The largest loan ETF, Invesco Senior Loan (BKLN), gained more than 4% and funds that buy CLO equity and lower-rated bonds also rallied.

The Fed program should be helpful, but investors need to get comfortable buying lower-rated slices of CLOs before the market can fully stabilize, said Scott Macklin, director of leveraged loan strategies at AllianceBernstein.

“The concern on lower tranches stems from aggressive loan downgrading activities by rating agencies, as well as a likely spike in company bankruptcies,” he added.

The Fed is also mandating that eligible CLOs be constructed as static vehicles, which are deals that have no period for managers to actively trade the loans that underpin the structures. While static CLOs make up a small portion of the market, the central bank’s support could lead to a flood of new static CLOs -- but that also hinges on the primary market firing up which could take a while.

“Our initial reaction is that the TALF program will not have much of an impact on supporting traditional broadly-syndicated loan CLO issuance,” said Laila Kollmorgen, portfolio manager at PineBridge Investments, referring to CLOs that buy loans arranged by banks and sold to investors.

(Updates to add Barclays comment in ninth paragraph.)

To contact the reporter on this story:
Lisa Lee in New York at llee299@bloomberg.net

To contact the editors responsible for this story:
Natalie Harrison at nharrison73@bloomberg.net

Adam Cataldo

© 2020 Bloomberg L.P. All rights reserved. Used with permission.

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