Goldman Sachs Plots Conquest of Wall Street's CLO Machine

(Bloomberg) -- Goldman Sachs Group Inc., seeking new revenue sources as its sales and trading businesses slump, is doubling down on the business of financing highly leveraged companies.

The bank’s latest area of focus is the marketplace where many of those high-risk loans ultimately end up after being bundled together into securities known as collateralized loan obligations, or CLOs, according to people familiar with the matter. The bank is creating and selling more of these CLOs to clients, adding to a boom in the market at a time when some analysts worry it’s becoming frothy. The CLO sales generate fees for Goldman Sachs as well as secure a source of demand for its loans, which in turn permits its bankers to more aggressively make them in the first place.

To further stoke demand for the CLOs it’s selling, Goldman Sachs is offering to finance clients’ purchases of the securities, according to the people. The bank has moved its CLO team into the same unit that houses its leveraged-finance bankers to help improve coordination, said the people, who asked not to be identified because they’re not authorized to speak publicly.

The bank has underwritten this year the biggest share of leveraged loans that were in turn sold to investors. And CLOs -- which are being created at an almost record pace -- are the biggest buyers of that debt.

“The two markets are integrally linked,” said Kimberly Flynn, managing director for alternative investments at Chicago-based XA Investments. “CLOs are a rapidly growing and important part of the leveraged loan market.”

Michael DuVally, a Goldman Sachs spokesman, confirmed the bank’s goal of growing its CLO business, describing the move as “consistent with our efforts across all our debt capital markets businesses.”

While Goldman Sachs has moved up by one slot this year to become the eighth most-active new CLO underwriter, it’s the biggest backer of institutional loans, arranging about $71.5 billion of deals this year from $41.7 billion in all of 2016, according to data compiled by Bloomberg.

Lucrative Fees

It’s been a banner year for CLOs, which repackage leveraged loans into bonds, with issuance eclipsing $100 billion, as low interest rates push investors toward riskier assets. For banks, underwriting CLO notes has proven to be very lucrative, with fees they pocket already at $1.3 billion this year compared to about $1 billion in all of 2016, according to Freeman Consulting Services, based on data from Thomson Reuters Corp.

“Goldman is going where the activity is,” said David Hendler, founder of Viola Risk Advisors and a veteran bank analyst. “Traditional asset managers have become much more involved in the loan, CLO product.”

The bank last year moved its CLO business from the securities, sales and trading unit on the public side into the financing group on the investment banking side, to align it more closely with leveraged loans, the people said. Goldman Sachs’ U.S. CLO new issue business is run by Amit Roy. The bank’s offering includes arranging new deals, refinancing existing funds and providing funding to investors buying CLO notes, said the people.

Goldman Sachs earlier this year started offering financing to managers who are unable to put up the 5 percent required under the new “skin in the game” regulations that took effect in 2016, the people said. The funding would allow managers to put in less of their own capital to conform with rules aimed at limiting risk taking.

Goldman Sachs’s CLO expansion comes amid a broader lending push, a departure for the bank from a bond-trading heritage it forged over decades. In the next three years the bank will make $5 billion in loans to sectors including structured credit and the middle market, co-president Harvey Schwartz said in a September presentation.

Unlike mortgage-backed collateralized debt obligations, CLOs came out relatively unscathed after the financial crisis. Among 1,392 CLOs rated by S&P Global Ratings since 1994, only 35 tranches across 20 deals have defaulted, the ratings company said in March.

Still, that shouldn’t be cause for complacency, according to Gene Tannuzzo, a money manager at Columbia Threadneedle Investments, which oversees $484 billion.

“It is a securitization structure that held up through the financial crisis, which can’t be said for others,” he said. “But we can’t get too comfortable with the statement that this is the cheapest AA or A asset out there. There’s always a risk.”

©2017 Bloomberg L.P.

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