2015 has started off with robust new fixed income issuance in virtually all asset classes. The backdrop for this, particularly since the end of January, includes the strong demand for credit product (as Fed rate hike expectations have been pushed back) and a global reach for yield (which has accelerated since the commencement of the European Central Bank (ECB) quantitative easing program). Rising oil prices have also greatly improved risk sentiment, given the relative weight of energy bonds in the corporate bond indices. Structured products are performing based on modest (yet positive) residential housing growth and improving commercial real estate prices. As a result, issuers continue to be aggressive in accessing the credit markets.
The one major outlier this year, however, has been syndicated leveraged loan new issuance, which is down 57% quarter over quarter. The dramatic drop in supply is largely attributable to increased regulatory pressure on banks and lack of leveraged buy-out (LBO) activity. The lack of supply, coupled with record demand via Collateralized Loan Obligation (CLO) issuance (the largest buyer of leveraged loans) has created a very supportive technical backdrop for the asset class. CLO origination has been robust, with first quarter 2015 new issuance up 36% versus the first quarter of 2014, which was itself a record year.
From a fundamental perspective, underwriting credit quality is hotly debated. Bears cite lack of covenants, rising leverage, and a weaker use of proceeds mix (less refinancing and more mergers and acquisitions); bulls cite lack of near term maturities, overall leverage levels well within historical ranges, strong interest coverage, lack of large LBOs, limited energy exposure, and stable revenue and earnings trends.
Valuation notwithstanding, I remain constructive on the domestic economy and feel the current extended credit cycle has a few more years to go, which should be supportive of underlying loan quality.
Key Takeaway: Limited loan supply is an important technical underpinning for CLO performance in 2015. This, coupled with strong demand, has led to solid total return performance for leveraged loans year-to-date, which has contributed to CLO performance. Other elements benefiting CLO performance are the growth of the investor base (which fuels demand) and the deleveraging nature of pre-crisis (CLO 1.0) deals, which takes supply out of the market. Moreover, recently implemented risk retention rules are expected to reduce CLO supply going forward. We continue to think CLOs offer attractive duration-adjusted relative value versus other asset classes. And, if short-term rates increase over the intermediate term, the appeal of the asset class will be further enhanced.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
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